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                                                   August i» 1991


                                                       en

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                                              /
 Mr. William K. Reffly                       !$
 Administrator
 U.S. Environmental Protection Agency
 Washington. DC 20460

 Dear Mr. Reilly:

       We are very pleased to transmit to you this Advisory of the Environmental Financial
 Advisory Board (die Board). It examines financing strategies to improve die ability of small
 communities to provide environmental facilities  and services.  Because small communities
 generally have a more Ifr™*^ range of available financing strategies than larger communities,
 small community issues are one of die most pressing financial challenges to accomplishing die
 nation's environmental goals.
       The Boaxd tits concluded that EPA must address die special challenges faced by
communities to ensure diat tiiey enjoy die same level of public health and environmental
protection as larger comrnnniTirs.  These small commnniiy financing strategies include:
             Improving coordination among small community financial assistance programs,
       •      Using bond banks to improve access to die bond market for gmaii communities,
             and

       *      Improving financial assistance to small ennimnmtfoa under Tide VI SRFs.

       I would Kfcq to tiumkEIizabem Ytell, Chair of die Small *"*f>mmnmty Financing Strategies
Workgroup for her leadership in keeping small community concerns at die forefront of die
Board's deliberations and in framing this Advisory. I also want to acknowledge die helpful input
of EPA's expert consultants to die HFAB (noted in Appendix E), particularly Ann Cole, EPA's
Small Community Coordinator.  On behalf of die entire Board, I would like to express to yon
our deep appreciation for the opportunity to assist EPA in addressing atnaii community financing
issues. We look forward to continuing our support and this dialogue in die future.

                                Respectively submitted,
Richard Torkelson
Chan*, Environmental Financial
Advisory Board

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                      TABLE OF CONTENTS


EXECUTIVE SUMMARY	  i


I. INTRODUCTION	   1
H. IMPROVING COORDINATION AMONG SMALL COMMUNITY
     FINANCIAL ASSISTANCE PROGRAMS	   7

     A. STATEMENT OF THE ISSUE	   7
     B. DISCUSSION	   8
     C. EPA SHOULD TAKE A LEADERSHIP ROLE IN MARSHALLING
          MULTIPLE FUNDING SOURCES FOR SMALL COMMUNITY
          ENVIRONMENTAL FACILITIES	   9
     D. EPA SHOULD SEEK IMPROVED COORDINATION BETWEEN SRFs
          AND FrnHA's WATER AND WASTE DISPOSAL PROGRAM  	  12
m. USING BOND BANKS TO IMPROVE ACCESS TO THE BOND MARKET
     FOR SMALL COMMUNITIES 		 .  15

     A. STATEMENT OF THE ISSUE	  15
     B. DISCUSSION	  17
IV. IMPROVING FINANCIAL ASSISTANCE TO SMALL COMMUNITIES
     UNDER TITLE VI SRFs 	  21

     A. STATEMENT OF THE ISSUE	  21
     B. DISCUSSION	  23
     C. THE ADMINISTRATOR SHOULD CONSIDER SEEKING
         ADMINISTRATION SUPPORT FOR LEGISLATIVE CHANGE TO
         TITLE VI OF THE CLEAN WATER ACT TO IMPROVE
         FINANCIAL ASSISTANCE TO SMALL COMMUNITIES 	  24
     D. EPA SHOULD ACTIVELY ENCOURAGE STATES TO GIVE MORE
         ATTENTION TO SMALL COMMUNITY NEEDS IN THEIR
         CURRENT SRF PROGRAMS	  30
NOTES	  37

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                  TABLE OF CONTENTS (Continued)
APPENDIX A
SMALL COMMUNITY FINANCIAL ASSISTANCE PROGRAMS	  A-l
APPENDIX B
CASE STUDY OF THE MAINE MUNICIPAL BOND BANK	  B-l
APPENDIX C
SRF AFFORDABILITY ANALYSIS  	  C-l
APPENDIX D
SMALL COMMUNITY PROFILES	  D-l
APPENDIX E
EFAB MEMBERS, WORKGROUP SUPPORT STAFF,
AND EXPERT EPA CONSULTANTS TO THE EFAB	  E-l

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                             EXECUTIVE SUMMARY
      The Environmental Financial Advisory Board (the Board) was established in August 1989
to advise the Administrator on ways to encourage and facilitate investment in environmental
facilities. Within the Board, the Small Community Financing Strategies Workgroup was formed
to explore financing strategies  to improve  the ability  of small communities to  provide
environmental facilities and services. This Advisory presents the analysis of the Board's Small
Community Financing Strategies Workgroup.
BACKGROUND

      To ensure that small communities enjoy the same level of public health and environmental
protection as  larger communities, EPA must address the  special challenges faced by small
communities in complying with environmental regulations.  Small communities generally have a
more limited range of available financing strategies than larger communities. This occurs because
larger communities benefit significantly from economies of scale, broader tax bases, and relatively
easy access to capital markets. Environmental and public health expenditures on a per capita basis
can be higher, while ability-to-pay often is lower in smaller communities.

      The need for capital investment in new, upgraded, or expanded environmental facilities is
increasing at the same time that federal financial assistance is declining.   Small communities
traditionally have relied on public subsidies from financial assistance programs to meet their
environmental facility needs. Recognizing that subsidies are not a panacea for small communities,
the Board has  focused its attention on ways to make the best use of existing financial assistance
programs, opportunities to expand the role of the private sector in leveraging small community
assistance, and strategies to increase the self-sufficiency of  small communities in financing
environmental facilities.
FINANCING STRATEGIES FOR SMALL COMMUNITIES

      In this Advisory, the Board examines three financing strategies for small communities:

      •      Improving coordination among small community financial assistance programs,

      •      Using bond banks to improve access to the bond market for small communities,
             and

      •      Improving financial assistance to small communities under Title VI SRFs.

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Improving coordination among email community financial assistance programs

       Recognizing that some small communities will require financial assistance to meet their
environmental facility needs, the first strategy is for EPA to take a leadership role in improving
coordination among small community financial assistance programs. A key part of this leadership
role is ensuring that spending on small community environmental facilities adequately addresses
environmental and public health needs and compliance with environmental regulations.   .

       A number of public programs currently provide financial assistance to small communities
for environmental infrastructure. These programs often are established for different purposes and
their resources generally have decreased over the last decade due to fiscal constraints. Improved
coordination among these programs would provide opportunities to leverage the available public
funds to better meet small community environmental facility needs. Broadening the coordination
efforts to include  increased private sector participation could benefit small communities by
expanding the range of available financing strategies.
Using bond banks to improve access to the bond market for small communities

       This strategy address one way to improve the self-sufficiency of small communities in
financing environmental facilities.  Bond banks help small communities obtain debt financing at
reasonable rates through pooling small bond issues and by providing credit enhancements.  By
seeking wider use of bond banks to finance environmental facilities, EPA can make debt financing
opportunities more available to small communities and help reduce their dependence on subsidized
assistance.
Improving financial assistance to small communities under Title VI SRFs

       Under Title VI of the Clean Water Act, state revolving funds (SRFs) are being established
to provide financial assistance to local communities, primarily in the form of loans for wastewater
treatment facility construction.  Small communities are experiencing problems under existing SRF
programs, including difficulty gaining access to SRFs and inability to afford SRF loans even at
low interest rates.

       Two strategies are available to better meet small community environmental facility needs
under the SRF program.  First, EPA could consider seeking legislative change to Title VI of the
Clean Water Act hi order to implement actions such as a small community set-aside,  a separate
multi-media revolving fund exclusively for small communities, or extended loan terms for small
communities.  Second, EPA should actively encourage states to implement other  actions to
improve financial assistance to small communities under their current SRFs.  Some states already
have taken some of these actions, including varying  interest rates based on ability-to-pay,
providing supplemental state grants for hardship cases, and providing technical assistance to small
communities.
                                                                               Pageii

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                                 I. INTRODUCTION
       Local governments play a major role in providing environmental services, including
wastewater treatment, drinking  water, and  solid waste management.  Total annualized local
government costs to implement major environmental regulations are expected to increase from
$19.2 billion in 1987 to $32.6 billion by the year 2000 (a 70 percent increase). Increases in local
government costs are driven primarily by expenditures for wastewater treatment and by revisions
to several environmental laws in recent years that establish broader and more stringent standards
for drinking water treatment, and disposal of sewage sludge and solid waste.1  While all local
governments face the challenge of raising the necessary funds, small communities are expected to
confront the greatest financing challenge to provide environmental and public health protection to
their residents.
SMALL COMMUNITY FINANCING PROBLEMS

       Small communities help shape the debate over financing strategies to meet the nation's
environmental goals because they generally have more limited financial capability and consequently
a more limited range of available financing strategies than larger communities.  Small communities
face special financing problems, many of which are linked to their inability  to benefit from the
economies of scale available to larger communities.2  In general, small communities confront
three types of financing problems in providing environmental services:

       *     Lack of access to capital can constrain or defer investment in new or expanded
             environmental facilities.

       •     Capital costs of facility construction can exceed the financial  capability of many
             small communities.

       •     Some low-income and/or very small communities may not be able to afford the
             costs of operating an environmental facility properly.

       Underlying these  financing problems are  a number  of factors  that characterize small
communities:

       *     Higher unit costs because small facilities lack the economies of scale that can be
             achieved by larger facilities.

       *     An inadequate  customer base to set user charges that support the full cost of
             providing environmental services.

       •     A low credit rating  or being unrated makes it difficult to issue debt or raises the
             interest costs of debt financing.

       »     Higher fixed costs of small bond issues (e.g., legal and underwriters fees) for those
             small communities that can obtain debt financing.


                                                                                 Page 1

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       •      Lower household incomes, .which reduces the ability of community residents to pay
             increased user charges, regardless of facility size.

       Several studies have examined the problem of financing infrastructure facilities in small
communities. In 1988, the National Council on Public Works Improvement concluded in Fragile
Foundations: A Report on America's Public Works that smaller public works systems face major
financial  and management problems and have special needs that must be addressed if small
facilities  are to provide the same services as larger facilities.3  A 1990 report by the U.S.
Congress, Office of Technology Assessment (OTA), Rebuilding the Foundations: A Special Report
on State and Local Public Works Financing and Management', found that small, rural communities
and low-growth jurisdictions have limited or no access to capital  and mat residents of these
communities have limited ability to pay higher user fees.  OTA concluded that such communities
face especially severe problems in financing environmental public works and are not  likely to
achieve compliance with EPA standards without increased state or federal assistance.4

       A recent EPA report compared the impact on households, for different city size categories,
of local government expenditures to comply with environmental regulations. This study concluded
that the average annual household cost of implementing current environmental regulations will be
much higher in smaller cities than large and medium-sized cities through the year 2000.  In the
smallest cities (less than 500 population), annual household costs to maintain current environmental
programs are expected to increase, on average, by about 88 percent, from $670 in 1987 to $1,263
in 2000.  For medium-sized cities (populations from 50,000 to 100,000), annual household costs
will increase by 38 percent, on average from $373 in 1987 to $515 in 2000.  Annual household
costs in large cities (populations greater than 500,000) will increase by 36 percent, from $393 in
1987 to $533 in 2000.  The cost of complying with new environmental regulations will add to
these increases in average annual household costs, representing an additional $317 for the smallest
cities, $24 for medium-sized cities, and $93 for large cities by the year 2000.5
SMALL COMMUNITY CAPITAL NEEDS

       The extent of small community financing problems is evidenced by estimates of capital
needs.   Needs  estimates  represent  only  the  capital  costs  of constructing and  upgrading
environmental facilities and do not include operation and maintenance (O&M) costs.

       Preliminary estimates of small community capital needs for wastewater treatment, drinking
water treatment, and solid waste management were developed for this Advisory based on various
estimates prepared  by EPA in Environmental Investments: The Cost of a Clean Environment.6
This report provided estimates of local government capital costs for implementing existing and new
regulations for point source water pollution control, drinking water treatment, and solid waste
management, under a present implementation scenario, during the 10-year period from 1991 to
2000.  Local government capital  costs for point source water pollution control represent local
wastewater treatment and sewerage costs, excluding federal and state grants to local governments.
Local government  drinking water capital costs  represent  costs associated with treating public
                                                                                Page 2

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 tanking  water supplies, excluding costs directly related to  supplying public drinking water
 (e.g., costs for water mains).  For drinking water treatment capital costs,  approximately 40
 percent are water treatment expenditures related to compliance with the Safe Drinking Water Act
 (SDWA).7  Local government solid waste capital costs represent expenditures for the collection
 and  disposal of solid waste  and  compliance with federal standards for solid waste disposal
 facilities.

       Capital costs to communities under 2,500 population are assumed to be 13.7 percent of
 total capital costs for wastewater treatment, 30.5 percent for drinking water treatment, and 5.9
 percent for solid waste management.8  These percentages were applied to the local government
 capital cost data described above  to estimate small community capital needs  by media for the
 10-year period from 1991 to 2000 (see Table 1-1).

       EPA's Municipal Sector Study estimated that 21 to 30 percent of small communities (less
 than 2,500 population) would have difficulty using revenue bonds, general obligation bonds, or
 bank loans to finance environmental infrastructure projects.9  Table 1-1 also gives estimates of
 capital needs for these "financially constrained*  small communities, assuming that 30 percent of
 small communities are financially constrained.
      Table 1-1. Preliminary Estimates of Small Community (less man 2,500 population)
                  Capital Needs for the 10-year Period from 1991 to 2000
                              (in billions of 1986 dollars)
Media
Wastewater Treatment*
Drinking Water Treatment**
Solid Waste Management
Total
Small Community
Capital Needs
$3.2
$5.5
$1.3
$10.0
Financially Constrained
Small Communities
$1.0
$1.6
$0.4
$3.0
   * Excludes federal and state grants to local governments.
  ** Approximately 40 percent of capital costs are related to SDWA compliance.
    Excludes costs associated with supplying drinking water.
SMALL COMMUNITY COMPLIANCE PROBLEMS

       Small communities have chronic and high rates of noncompliance with environmental
regulations.  For small communities, noncompliance often is evidence of financing problems
although managerial and  technological  problems also may contribute to small community
noncompliance.
                                                                               Page 3

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       EPA's Office of Drinking Water has the most complete compliance data on small facilities.
Nearly 70 percent of all violations of the Safe Drinking Water Act occur in very small community
drinking water systems (i.e., those serving between 25 and 500 persons).  Around two-thirds of
the nearly 60,000 community drinking water systems in the United States serve less than 500
persons, but these very small systems serve only 2.5 percent of the nation's population.10

       Recent environmental legislation has expanded the range of environmental concerns that
must be addressed by local governments and has increased the stringency of environmental
standards. The cumulative costs of new and more stringent environmental requirements will only
serve to exacerbate the difficulties that small communities already face in complying with existing
requirements.
THE DIVERSITY OF SMALL COMMUNITIES

       While the typical small community generally experiences the financing problems described
above, it is important to recognize the diversity that exists among small communities. First, small
communities can vary widely in financial condition. A broad range of financial capabilities exists
from affluent, mostly suburban, small communities that have favorable credit ratings to issue debt
to true hardship cases that would require substantial  financial assistance.11  Second, small
communities represent a range of population sizes and densities. While the distinction as "small"
typically is based on the population served by a facility, there is no widely accepted definition
regarding "how small is small."

       To provide some perspective on the number of small communities in the United States and
the proportion of the population residing in those communities, Table 1-2 presents the most recent
census data showing the distribution of the U.S. population by size of place.12  Around 98
million persons, or 43 percent of the U.S. population, resided in communities of less than 10,000
inhabitants in 1980. About 74 million persons, or 32 percent of the U.S. population, resided hi
communities of less man 2,500 inhabitants. Table 1-3 shows population  data for communities
under 10,000 population by major census region." In 1980,  the southern  United States had the
•greatest number of persons residing in these smaller communities.
                                                                               Page 4

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       Table 1-2. Population of the United States by Size of Place

Size of Place
URBAN:
100,000 or more
50,000 - 100,000
25,000-50,000
10,000 - 25,000
5,000 - 10,000
2300-5,000
Less than 2,500
Other urban
RURAL:
1,000 - 2^00
Less than 1,000
Other rural
TOTAL;
Source: 1980 Census
Number of
Places

173
290
675
1,765
2,181
2,665
1,016


4,434
9,330

22,529
of Population
Percent of
Total Places

0.8
1.3
3.0
7.8
9.7
11.8
4.5


19.7
41.4

100

Population
(millions)

57.5
19.8
23.4
27.6
15.4
9.4
1.3
12.7

7.0
3.9
48.6
226.5

Percent of Total
Population

25.4
8.7
10.3
12.2
6.8
4.1
0.6
5.6

3.1
1.7
21.4
100

Table 1-3. Population in Smaller Places (10,000 or less) by Census Region
Population (in millions)
Size of Place

URBAN:
5,000 - 10,000
2,500 - 5,000
Less than 2,500
Other urban
RURAL:
1,000 - 2,500
Less than 1,000
Other rural
TOTAL:
Source: 1980 Census

Northeast

3.7
1.8
0.4
4.1

1.3
0.3
8.7
20.3
of Population
North
Central

3.8
2.6
0.3
2.7

2.4
1.9
13.1
26.8


South

5.4
3.5
0.5
3.9

2.5
1.3
21.2
38.3


West

2.5
1.4
0.1
1.9

0.9
0.4
5.6
12.8

Total
U.S.

15.4
9.4
1.3
12.7

7.0
3.9
48.6
98.3

                                                                         PageS

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ADDRESSING  SMALL  COMMUNITY  FINANCIAL  CAPABILITY  TO  MEET
ENVIRONMENTAL GOALS

       The Environmental Financial Advisory Board (the Board) is charged with identifying and
examining financing strategies to advance the pursuit of environmental goals as articulated in
federal environmental statutes.  Within the Board,  the Small Community Financing Strategies
Workgroup is charged with exploring what financing strategies can be implemented to improve
the ability of small communities to provide environmental facilities and services.

       After examining small community financing problems, the  Board has identified two
primary issues that lead to special challenges for small communities — access to capital and
affbrdability.  Lacking access to capital lor construction or upgrading environmental  facilities,
small communities  will have  difficulty  complying  with environmental  regulations.   The
affbrdability issue relates to a community's ability  to pay for needed environmental  facilities.
Affbrdability is an important concern in determining the type, amount, and conditions of financial
assistance that could be provided to help small communities meet their environmental facility
needs.

       The Board has considered a range of alternative financing strategies for small communities
as well as new institutional opportunities to help  small communities meet the challenge of
financing needed environmental services.  In this Advisory, the Board considers three small
community financing strategies!

       •      Improving coordination among small community  financial assistance programs,

       •      Using bond banks to improve access  to the bond market for small communities,
             and

       •      Improving financial assistance to small communities under Title VI SRFs.
                                                                             Page 6

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     . IMPROVING COORDINATION AMONG SMALL COMMUNITY FINANCIAL
                            ASSISTANCE PROGRAMS
      The Board has concluded that opportunities exist where improved coordination among small
community financial assistance programs can help small communities meet their environmental
facility needs.  A number of public programs currently provide financial assistance to small or
low-income communities or rural areas for wastewater and drinking water facility construction or
improvements.  To provide the maximum benefit to small communities, the Board found that
coordination among financial assistance programs should be broadened to include both public and
private sector sources of capital.  The existence of multiple funding sources, both public and
private, expands the overall level of funding available for small environmental facilities and adds
flexibility  in developing financing strategies for small communities.  By seeking  improved
coordination among financial assistance programs, EPA can help small communities find the most
appropriate funding source or help combine existing funding sources to leverage the available
funds.

      Recognizing that EPA has a mandate to ensure that small facilities achieve compliance with
federal environmental regulations,  EPA should seek to structure coordination among financial
assistance programs to foster agreement on environmental facility needs and overall priorities.
The Board believes that EPA can play a significant role in ensuring that spending on small
community environmental  facilities emphasizes environmental and public health needs  and
regulatory  requirements.
A. STATEMENT OF THE ISSUE

      The Board examined programs that provide financial assistance to small or low-income
communities or rural areas for environmental infrastructure projects. These programs include
financial assistance programs administered by federal agencies, by state agencies where a federal
program is administered at the state level, and a federally chartered financial institution, CoBank,
which plays an important role in rural areas.  These sources of financial assistance to small
communities are listed below (see Appendix A for a more detailed description of each program).

      •      State Revolving Fund (SRF) Program.  The SRF is administered by the states
             and funded by capitalization grants from EPA and state matching funds.  SRFs
             primarily  award loans to  local governments for construction of wastewater
             treatment facilities.

      •      Water  and Waste Disposal Loan and  Grant Program.  This program is
             administered by the Farmers Home Administration (FmHA), U.S. Department of
             Agriculture.  The FmHA Water and Waste Disposal Program provides loans,
             grants, and loan guarantees primarily for water and wastewater systems that serve
             rural areas or communities under 10,000 population.  The 1990 Farm Bill created
             me Rural Development Administration (RDA) and requires transfer of the FmHA
             Water and Waste Disposal Program to the RDA.
                                                                             Page?

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       •      Public Works and Development Facilities Grant Program. Administered by the
             Economic Development Administration (EDA), U.S. Department of Commerce,
             this  program awards  grants  to. finance  construction  of public  works  and
             development facilities  (including water and  wastewater facilities)  to  promote
             long-term economic development

       *      Community Development Block Grants (CDBG)/Small Cities Program.  The
             CDBG/Small Cities Program is funded by the Office of Community Planning and
             Development, U.S. Department of Housing  and  Urban Development  (HUD).
             Administered principally by the states, CDBG/Small Cities funds provide grants for
             activities that benefit  low-income  communities.  These grants can be  used to
             construct public facilities such as water and wastewater systems.

       •      Partners for Environmental Progress (PEP) Initiative. PEP is a new initiative
             of the U.S. Army Corps  of Engineers that will provide financial  assistance for
             market feasibility studies to  help small  communities  find ways to privatize
             environmental services.

       •      Appalachian  Regional Commission (ARC) Supplemental  Grants.  ARC's
             supplemental grants program provides grants to supplement other federal grants to
             fund community'development facilities such as water and wastewater systems.

       •      CoBank, the National Bank for Cooperatives.  CoBank is a federally chartered
             and regulated financial institution mat received expanded authority under the 1990
             Farm Bill to finance water and wastewater systems in communities under 20,000
             population.

       While all of these programs finance wastewater and drinking water projects to some extent,
the Board has observed that improving coordination among the various financial assistance
programs would help small communities develop more effective financing strategies to  provide
environmental facilities.  No single program can be expected to meet all of the environmental
facility needs of small communities.  Because the needs and priorities of small communities are
different, the existence of multiple funding sources offers small communities greater flexibility in
developing financing strategies.  Furthermore,  with improved coordination among financial
assistance programs, small communities can take advantage of opportunities to leverage the
available funds by combining funding sources.
B. DISCUSSION

      The Board evaluated potential opportunities for improved coordination among financial
assistance  programs  by examining the  underlying  objectives and funding priorities of each
program.  The SRF program provides financial assistance to local communities for construction
of wastewater treatment facilities, with the overall objective of meeting the water quality goals of
the Clean Water Act Coordination efforts between EPA and other financial assistance programs
could either be linked to the SRF program or more generally seek to ensure that funds are targeted
to meeting the most serious environmental facility needs of small communities.


                                                                             PageS

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       The Board has found that the greatest opportunities for improved coordination exist with
 die Water and Waste Disposal Loan and Grant Program, currently administered by the Fanners
 Home Administration. The Water and Waste Disposal Program provides funding targeted to water
 and wastewater treatment facilities in rural areas. Given its direct focus on funding environmental
 facilities and rural areas, coordination efforts between the Water and Waste Disposal Program and
 EPA are likely to achieve the greatest results in meeting small community environmental facility
 needs.  While financial assistance for water and wastewater facilities also is provided under the
 ARC supplemental grants program, these funds are made available only if they conform to state
 Appalachian development plans and only for specified Appalachian counties.

       The EDA and HUD programs  appear to offer some  opportunity  where improved
 coordination could help small communities meet  their environmental facility needs.  EDA's
 program is oriented to economic development and the CDBG/Small Cities funds provided by HUD
 are oriented to helping low-income communities. Because many types of projects are eligible for
 funding under the EDA and HUD programs, applications for water and wastewater treatment
 projects would have to compete against other needs. Given mat the EDA and HUD programs are
 less directly focused on environmental facilities, coordination efforts between EPA and these two
 programs may not provide the same level of benefits to meeting small community environmental
 facility needs as the Water and Waste Disposal Program.

       As the Corps of Engineers PEP initiative already is being designed to complement EPA's
 Public-Private Partnerships initiative, the Board supports mis existing coordination effort. In
particular,  the Board  supports efforts currently underway to  develop  a Memorandum of
 Understanding between  EPA and the Corps regarding their respective roles in  helping  small
 communities provide environmental services through public-private partnerships.

       With its expanded authority tinder  the 1990 Farm  Bill,  CoBank is  poised to provide
 potentially  significant financial  services to rural  communities for construction  of water and
 wastewater systems.  The Board  has concluded that CoBank's new authority offers EPA an
 opportunity to take innovative steps to work with CoBank to assure mat facilities constructed with
 CoBank loans will comply with applicable environmental regulations.   As part of such a
 coordination effort, for example, EPA could provide guidance establishing minimum standards of
 planning, design, and construction for rural water and wastewater systems.


 C. EPA SHOULD TAKE A LEADERSHIP ROLE  IN MARSHALLING  MULTIPLE
 FUNDING SOURCES FOR SMALL COMMUNITY ENVIRONMENTAL FACILITIES

       The Board believes that EPA should  take a leadership role to coordinate multiple funding
 sources and develop the capacity of small communities to finance environmental facilities. As part
 of this  leadership role, EPA should ensure that spending on small  community environmental
                                                                             Page 9

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facilities adequately addresses  environmental and public health needs and  compliance with
environmental regulations.  The Administrator may wish to consider two actions in this regard:

       •     Make a public statement highlighting the financial services and programs available
             to small communities in complying with environmental mandates, and

       •     Convene a roundtable of small community financial assistance programs.
The Agency should make ft public statement highlighting the ffoflnrM services and programs
available to »»*mn communities in complying with environments!
       The Board recognizes that for some time EPA has emphasized and supported assistance
to small communities, most notably through its publications and various financial and technical
assistance programs. Largely as a function of the Agency's organization along media lines, small
community activities traditionally have been carried out separately by media offices, and at least
in the case of the Office of Water, by each of the several line programs within the office.  The
Board's concern is that the beneficiaries of these worthwhile programs — the small communities
themselves — have to deal with the totality of federal and state environmental mandates, and hence
may not be able to access or use effectively assistance delivered in a fragmented fashion.

       The Board believes small communities could benefit from the issuance of a consolidated,
multi-media statement that presents in one document the various programs and types of assistance
available from EPA as well as the various rules affecting local governments. The Agency's Small
Local Government Work Group currently is compiling such information.

       To supplement this important activity, the Board recommends that the Agency develop a
financial assistance catalog for small  communities in complying with environmental mandates.
The catalog would include (1) a clear, detailed description of federal grant, loan, and credit
enhancement programs available to small communities; (2) technical advisory services concerning
financial issues for small communities; (3) financial assistance and advisory services provided by
nonprofit organizations; (4) criteria and techniques for assessing community financial capability
and affordability based on the work of the Agency's Affordability Work Group; and (5) types and
uses of public-private partnerships applicable to the needs of small communities.
The Administrator should convene 8 roundtable of small community finanrfai assistance
programs

      To enhance EPA's leadership role in marshalling multiple funding sources for small
community environmental facilities, the Administrator should consider convening a roundtable of
small community financial assistance programs. Representatives of all small community financial
assistance programs, both public and  private, would be invited to participate in the roundtable.
The purpose  of the roundtable would be  to facilitate improved coordination among small
community programs and examine ways that such coordination can lower the costs of providing
environmental services, promote effective small community compliance strategies, and encourage
innovation.


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The agenda of the roundtable should address these needs:

•     Ways  and means to effect improved coordination among small community
      financial assistance programs. A primary charge of the roundtable should be to
      foster agreement on environmental  facility needs and overall priorities among the
      many small  community programs.  Various ways  and means are available to
      coordinate community development, for example, with the goal of achieving full
      compliance  with  environmental regulations.   Options  for- discussion at the
      roundtable could include an Executive Order, Memorandum of Understanding,
      Memorandum of Agreement, or an Interagency Agreement

•     Coordination of small community financial assistance program^ with EPA's
      geographic  initiatives.  The Board recognizes  that the Agency's geographic
      initiatives will have an increasingly important role in directing Agency resources
      to solving environmental problems.  Within each of these geographic initiatives, the
      Administrator  may wish to consider developing  a financial  plan for small
      community environmental facility  needs.  The roundtable should facilitate the
      coordination of multiple funding sources in addressing small community needs as
      they affect the objectives of EPA's geographic initiatives.

•     Mechanisms to promote pollution prevention.  The Board supports pollution
      prevention as an  emerging alternative strategy  to investing in  environmental
      facilities for cleaning up pollution or managing  wastes.  However, the Board
      recognizes that pollution prevention strategies will require a fundamental shift in
      approach, as well as new technologies, before such strategies can be implemented
      in either large or small communities. The roundtable should address how financial
      assistance programs can incorporate pollution prevention strategies to benefit small
      communities.

•     Collection and exchange of more detailed information about small community
      environmental faculty needs for all media.  The Board has found  that lack of
      information  about  small  community environmental   facility needs   for all
      media  — wastewater, drinking water, and solid waste — makes it difficult to assess
      adequately  the  extent of these needs.   More detailed information on small
      community needs by media is needed to set priorities and to facilitate coordination
      efforts among small community financial assistance programs. The roundtable also
      should examine ways to increase exchange of  this information among small
      community financial assistance programs as well as with the private sector.

*     Mechanisms and incentives to encourage private sector participation.  The
      Board  concurs with EPA's initiatives to promote public-private partnerships to
      finance environmental services.  The roundtable should  explore ways that other
      agencies can establish programs  to support  public-private partnerships as  an
      effective financing strategy for small communities.

•     Improvements  in technical assistance  and  outreach efforts.   The Board
      acknowledges that technical assistance has long been recognized as a crucial factor


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             in constructing as well as improving  the performance of small environmental
             facilities.  Many sources of technical assistance - ranging from state and federal
             agencies to nonprofit organizations, professional associations, and universities —
             already are available. The roundtable should seek to identify and to put into place
             technical assistance that provides more practical advice tailored to the needs of
             small communities. In addition, the roundtable should seek ways to better educate
             local governments about environmental regulations as part of the outreach efforts
             of all small community programs.
D. EPA SHOULD SEEK IMPROVED COORDINATION BETWEEN SRFs AND FmHA's
WATER AND WASTE DISPOSAL PROGRAM

       The Board has found that FmHA's Water and Waste Disposal Loan and Grant Program
provides the greatest opportunities for improved coordination with the SRF because this program:
(1) targets rural areas and small communities (less than 10,000 population), (2) targets water and
wastewater systems, (3) takes explicit account of a community's financial capability in determining
the type of assistance provided, and (4) provides grants to reduce user charges to affordable levels.
In addition, the creation of the Rural Development Administration (RDA) and the transfer of the
Water and Waste Disposal Program to this new  agency offers an opportunity to seek improved
coordination as this change is taking place.

       The Board has identified two actions to develop improved coordination between the SRF
and the Water and Waste Disposal Program that, in the Board's  opinion,  would provide  the .
maximum benefits to meeting small community environmental facility needs. These actions are:

       •      EPA should encourage state agencies administering SRFs to improve coordination
             with state offices administering the Water and Waste Disposal Prog
                                                                       ram.
             EPA should provide information to the Water and Waste Disposal Program on
             small community environmental facility needs and die importance of specific
             environmental and public health criteria that should be considered in the allocation
             of funds among states.
EPA should encourage state agencies administering SRFs to improve coordination with state
offices administering the Water and Waste Disposal Program

       Recognizing that the Water and Waste Disposal Loan and Grant Program is administered
through FmHA's state and district offices and that the SRF program is administered by the states,
the Board believes that EPA should encourage a closer working relationship between SRFs and
FmHA state offices.  These coordination efforts should continue as the Water and Waste Disposal
Program is transferred to the RDA.

       The objective of these coordination efforts could be to direct small communities to the most
appropriate funding source  or to combine these funding sources to finance small community
wastewater projects. Combining SRF loans with Water and Waste Disposal loans or grants can


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"leverage the available funds for financing wastewater projects.  The Board believes that efforts to
 combine funding sources should be targeted to those small or low-income communities with the
 greatest need. EPA can encourage SRFs to seek improved coordination with the Water and Waste
 Disposal Program through program guidance, technical assistance documents, workshops, and
 conferences.

        Some states already have developed programs in which small communities benefit from
 coordination between the SRF and the Water and Waste Disposal Program as well as other state
 or federal  financial assistance programs.  The Board has identified two exemplary state-level
 coordination efforts,  described below, that can serve as examples for other states.

        The state of Minnesota has developed a unified application process that channels applicants
 to the state or federal assistance program most appropriate for their infrastructure project This
 unified application process involves cooperation among Minnesota's state grant program, the SRF,
 and the FmHA, HUD,  and EDA programs. The state grant program provides 65 percent grants
 to communities of 25,000 population or less and 35 percent grants to larger communities.  To
 provide affordable financing for wastewater projects in smaller communities, Minnesota combines
 grants  with loans to tailor a financing package to the needs of a specific community.   By
 combining state and federal funding sources, Minnesota's  program can provide affordable loans
 to the state's smaller communities and maximize the effectiveness of the available grant funds.14

        In the state of Washington, a unique  cooperation  effort has substantially improved  the
^ability of local communities to access both state and federal assistance programs. Two years ago,
 the state created the Inter-Governmental Public Facility Finance Committee, which is composed
 of representatives from the SRF, FmHA, HUD, and EDA programs as well as representatives
 from several state assistance programs. The committee meets every month to discuss opportunities
 for  cooperation and to plan  for their annual Inter-Governmental  Public Facility Finance
 Conference.  Communities in the state send representatives to  the conference to learn about the
 available state and federal assistance programs.  Each agency markets their services to local
 communities through separate presentations describing their assistance programs. The conference
 also offers seminars  on how to finance  particular types of projects or how to access combined
 financing from different grant and loan programs.  Because local communities are able to obtain
 information about all of the available financial assistance programs, they can pursue the most
 affordable financing strategy.15
 EPA should provide information  to  the Water and Waste Disposal Program  on small
                          facility needs and the importance of specific environmental and
 public health criteria that should be considered in the allocation of funds among states

       The Board believes that EPA has an opportunity to work with the Water and Waste
 Disposal Program to help direct federal resources to the most serious environmental facility needs
 of small communities in rural areas. Currently, state-by-state allocation of funds under the Water
 and Waste Disposal Program is based largely on rural population. By providing information on
 small community environmental  facility needs and specific environmental and public health
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criteria, EPA can encourage consideration of these issues in the program's allocation of funds
among states.

       The Water and Waste Disposal Loan and Grant Program already considers environmental
and public health criteria at the state level when proposed projects are evaluated and rated. As
such, these criteria are a factor in FmHA's final allocation of funds to eligible projects. However,
the Board has concluded that consideration of these criteria at the national level when funds are
allocated among states also would benefit small communities by targeting limited federal resources
to those states with the most serious rural problems.
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      USING BOND BANKS TO IMPROVE ACCESS TO THE BOND MARKET FOR
                              SMALL COMMUNITIES
       Small communities that need to borrow money for environmental infrastructure projects
often are unable to do so in the national bond market because of poor credit ratings, little financial
expertise, and their relatively small capital needs. Without the ability to obtain debt financing,
such communities may only be able to finance their environmental facility needs through state or
federal financial assistance programs.  While acknowledging that some small communities will
require financial assistance, the Board maintains that the provision of subsidies through financial
assistance programs should not be considered a panacea for the financing problems of small
communities.  The Board has concluded that bond banks are a financing strategy that can make
debt financing opportunities more available to small communities and  can help  reduce  the
dependence of small communities on subsidized assistance.
A. STATEMENT OF THE ISSUE

      Bond banks are financial institutions created primarily to provide smaller communities
access to the national bond market for financing infrastructure projects.  A bond bank purchases
local government debt and pools these smaller bond issues into a large offering to sell in the bond
market.  Bond banks are used to finance a variety of projects, including water, sewer, road, and
school construction. Because bond banks have been successful across the country in financing
small community infrastructure projects, the Board believes that the bond bank concept offers an
effective financing strategy for small community environmental facility needs.   The following
sections provide an initial analysis of the bond  bank concept.

How a Bond Bank Works

      Bond banks typically are structured in  one of two ways.  A bond bank  either (1) sells
bonds in the bond  market and uses the proceeds to purchase bonds from local communities, or
(2) buys bonds directly from local communities and pools several small issues into one large bond
issue to be sold in the  bond market. Bond pools can be "designated" (i.e., projects already have
been identified when  the issues are pooled) or "blind"  (i.e., specific  projects  have not been
identified when the bond bank sells its bonds).  Proceeds  from the pooled bond issue are loaned
to the participating local communities, which repay the loan from facility revenues or from other
local revenue sources.

        Bond banks usually are backed by several security provisions. Most states  with bond
banks do not pledge their "full faith and credit" to back a bond bank's debt. Typical security
provisions of bond banks include:

      •      Repayment agreements with the  local communities,

      •      A debt  service reserve fund to repay the bonds if other sources are not sufficient
             (the debt service reserve usually holds enough funds to ensure the maintenance of
             a bond  bank's debt service requirements for one year),


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       •     A "moral obligation" pledge by the state (i.e., a nonbinding pledge to use future
             state appropriations to repay bonds if necessary or to replenish the debt service
             reserve if depleted by the default of a local government), and

       •     Liens on state financial assistance, or an "intercept mechanism," through which the
             bond bank may seek to withhold state payments to a local government in the event
             of default.

       For small communities, the major advantages of using a bond bank are to gain access to
the bond market and to lower interest rates and issuance costs. For a community that is unrated
or has a poor credit rating, a bond bank's higher credit rating and security provisions usually
provide a lower interest rate on the pooled issue.  Interest rates are further reduced because
pooling smaller bond issues enables diversification,  which reduces the risk of default.  Pooled
issues reduce fees and other up-front issuance costs since each community pays only its share of
these fixed costs. Communities also benefit from other economies of scale associated with the
pooled issue, such as lower administrative costs as a result of centralized administration by the
bond bank.  Bond banks also facilitate marketing of issues. Pooled issues are more attractive to
underwriters because, being larger, they are easier to sell in the secondary market16

State Experience with Bond Banks

       At least 11 states and the Commonwealth of Puerto Rico have established bond banks to
enable local governments to gain access  to the bond market and to create savings for local
governments in the issuance of debt. Vermont created the first bond bank in 1969. Other states
that have established bond banks are Alaska, Illinois, Indiana, Maine, Michigan, Mississippi, New
Hampshire, Nevada, North Dakota, and Oregon.  The Board has selected the Maine Municipal
Bond Bank, which is one of the more active and successful bond banks, as a case study of the
bond bank concept (see Appendix B).

       Bond banks vary in their financing characteristics because states generally have adapted the
bond bank concept to meet their particular needs.  Such differences include how bonds  for
different types of projects are pooled, what types of  bonds are purchased, and special programs
to meet specific  financing needs.  For  example, the Maine, Vermont, and Indiana bond banks
purchase bonds for several different types of projects (e.g., water, sewer, school) and pool them
into  a single "umbrella issue" to sell on the bond market.  Other  bond banks, such as the New
Hampshire bond bank, pool bonds for different types of projects separately.  The Vermont bond
bank purchases  only general obligation (GO) bonds, while the Maine and Indiana bond banks
purchase both GO and revenue bonds from participating local communities.  The Indiana bond
bank has a special program for communities with weaker credit ratings and purchases commercial
insurance for these bond issues.  Some bond banks, including the Maine and Indiana bond banks,
provide refinancing of Farmers Home Administration loans, creating savings for communities on
the costs of existing projects.17
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 X DISCUSSION

       Bond banks have demonstrated both the ability to earn favorable credit ratings and help
 small communities obtain debt financing at reasonable  rates.  Because bond banks provide a
 mechanism for encouraging increased reliance on debt financing by small communities, the Board
 has found that the bond bank concept can make significant contributions to financing small
 community environmental facility needs.  Because bond banks also can help reduce the need for
 small community subsidies, the Board believes that the Administrator should consider seeking
 wider use of bond banks as a means of facilitating capital financing for small communities.

       This section examines several actions that the  Administrator may wish to consider with
 regard to seeking wider use of bond banks. The first two actions, which address what EPA could
 do now to encourage wider use of bond banks, are:

       •      EPA should provide technical assistance on the establishment and  use of bond
              banks, and

       •      EPA should identify barriers to effective bond bank operations and develop
              strategies to overcome those barriers.

       The third action addresses a more innovative approach that the Board believes holds much
 promise for expanding the bond bank concept in a manner that could offer even greater benefits
 to small communities.  This third action  is:

       •      EPA should explore the financial, legal, and administrative feasibility of creating
              a regional or multi-state institution to facilitate issuance of tax-exempt bonds by
              small communities.
 EPA should provide fty%iiTfli assistance on the establishment and use of bond banks

       Technical assistance can help states that have not yet created bond banks to establish new
 bond banks or help states that already have bond banks to improve the effectiveness of these
 financial institutions in meeting small community environmental  facility  needs.   The Board
 recognizes that each state is unique and that it can be difficult to consider the range of goals,
 needs, and circumstances across all SO states.  Nevertheless, EPA can provide technical assistance'
 on bond bank operations, advantages, and pitfalls, thus enabling states to evaluate the bond bank
 concept and how it can be used to meet small community environmental facility needs in their
 state. Such technical assistance can be delivered through publications, workshops, or conferences.

       The Administrator also could consider providing technical assistance to encourage states
 to incorporate beneficial features of bond banks into their state financial assistance programs,
 whether or not these programs would then  act specifically as a  bond bank.  The Board has
^identified Texas as a state where bond bank features are incorporated successfully into the state's
 financial assistance program.  The  Texas Water Development Board (TWDB) administers state
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assistance programs that provide loans for the construction of water and wastewater facilities.
TWDB  has  included the purchase of local debt as part of the assistance provided to  local
governments through these water and wastewater loan programs. TWDB also administers the SRF
and has elected to purchase tax-exempt municipal bonds from local governments under the SRF.
Funding for TWDB programs is obtained from the sale of Texas Water Development Bonds,
which are secured by the full faith and credit of the state. Since the state presently has an AA
rating, participating local governments can benefit from the state's lower interest costs.18

     ,  It is important to note that a bond bank cannot act as a revolving fund. A fundamental
difference between bond banks and revolving loan  funds  is that unlike SRFs, bond banks are
limited to obtaining capital from the bond market.  Bond banks must constantly go back to the
bond market for new capital because loan repayments from local governments are used to pay debt
service  on previous bond issues.  In contrast, revolving loan funds are designed to create a
permanent source of capital for making loans to local communities.  After me initial capitalization
of SRFs, loan repayments from communities are used to replenish the fund and to make loans
available to other communities.  A revolving fund, if managed properly, builds equity over time,
while a bond bank builds very little equity or none at all.  Finally, because bond banks rely on
the sale of bonds backed solely by loan repayments,  they cannot offer the interest rates subsidies
that are available through SRFs.19

       While the concept behind SRFs and bond banks is different, this does not limit states'
flexibility in operating these financial institutions. In  Maine, the SRF was formed as a cooperative
effort between the Maine Department of Environmental Protection, which acts as project manager
for the program, and the Maine Municipal Bond Bank (MMBB), which is the financial manager
of the fund.  MMBB created a separate account for the  SRF to accept the EPA capitalization
grants and the required state match, which was raised through general obligation bonds  issued by
the state of Maine.  Through this cooperative effort, Maine can take advantage of MMBB's 20
years of experience in financial management to administer its SRF as a separate account of the
state bond bank.30
EPA should identify barriers to effective bond bank operations and develop strategies to
overcome those barriers

       The Board has found that certain provisions of the 1986 Tax Reform Act have effectively
increased the costs of operating a bond bank and reduced the savings to local governments from
participating in a bond bank.21  Tax issues appear to be the most significant barriers to the
effective operation of bond banks and consequently can act as barriers to the establishment of bond
banks in states that do not yet have them. -

       Provisions in the 1986 Tax Reform Act that restrict arbitrage earnings, for example, have
had a significant impact on bond banks.  Prior to the 1986 Tax Reform Act, bond banks typically
used arbitrage earnings to fund their administrative and issuance costs.  For most bond banks, mis
included arbitrage earnings from the short-term investment of bond proceeds before funds were
loaned to participating local governments and arbitrage earnings from accumulations on the debt
service reserve fund. Restrictions on arbitrage earnings in the 1986 Tax Reform Act limit the
amount of arbitrage earnings and increase the costs of issuing bonds because of the need to track


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 rbitrage earnings. Another provision of the 1986 Tax Reform Act that has affected bond banks
is the restriction on the size of the debt service reserve fund.   Prior to the Act, bond banks
typically maintained debt service  reserve funds equaling maximum annual  debt service, thus
providing a credit enhancement that lowered interest costs for bonds issued by the bond bank.

       The Board's Economic Incentives Advisory has addressed the impact of the 1986 Tax
Reform Act on state and local financing of environmental facilities. The Administrator should be
aware that provisions  of the 1986 Tax Reform Act also impact the ability  of state and local
governments to finance environmental facilities through bond banks. To encourage wider use of
bond banks, EPA should  identify barriers to  effective bond bank operations, such as those
presented by tax issues, and take action to develop strategies to overcome those barriers. As part
of this  effort, EPA  should  work with existing bond  banks to encourage the exchange  of
information about how they have handled tax issues.
EPA should explore the fjnanfinij legal) and administrative feasibility of creating a regional
or multi-state institution to facilitate issuance of tax-exempt bonds by small communities

       The Board has observed that some of the advantages of bond banks could be extended if
regional or multi-state financial institutions were created to facilitate issuance of tax-exempt bonds
by small communities.  As the Agency is undertaking a number of geographic initiatives that are
regional or multi-state in scope, the Board has given some consideration to this more innovative
approach to the bond bank concept

       Regional or multi-state financial institutions could enable small communities to finance
environmental facilities at favorable  interest rates by offering the greater diversification and
economies  of scale possible with a larger size pooled  bond issue and by providing security
mechanisms.  First, greater diversification from pooling  a larger number of small issues should
enhance the credit rating of a regional or multi-state institution and lead to lower interest rates for
participating communities. Second, the greater economies of scale associated with larger pooled
issues would  reduce the share of issuance costs for each participating community. Finally, by
spreading administrative costs over a larger pool, any  fees necessary to cover administrative
expenses also could be kept low.

       Although the proposed regional or  multi-state  financial institutions appear to  otter
advantages to small communities, the Board has observed that there are many questions regarding
their financial, legal, and administrative feasibility, which must be explored.  While mere are
precedents for financial institutions that purchase and remarket tax-exempt bonds, there is no
precedent for a conventional bond bank on  either a  multi-state or  regional basis. Alternative
models  should be developed for the purpose of evaluating all of the financial, legal, and
administrative issues.

       The revenue  impacts  on  the  U.S.  Treasury of the proposed  regional or multi-state
institutions also should be studied.  Since it is contemplated that the use of such institutions would
be confined to governmental units that are legally entitled to issue tax-exempt debt to finance
environmental projects, there should be no revenue loss to the U.S. Treasury.  Furthermore, since
reducing the  interest rates on tax-exempt bonds reduces the total amount of exempt interest

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income, there may actually be a reflow gain to the U.S. Treasury  from such  institutions.22
Because such questions are critical to the overall viability of the proposed institutions, the Board
advises the Administrator to request an analysis of the total  financial impact of  the proposed
regional'or multi-state financial institutions on the U.S. Treasury.

       The Board's consideration of these issues has resulted in a preliminary assessment that
expanding the use of the bond bank concept to regional or multi-state institutions shows enough
potential to merit further study. The Board encourages the Administrator to consider this more
innovative approach, particularly as it relates to supporting the Agency's geographic initiatives.
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  IV. IMPROVING FINANCIAL ASSISTANCE TO SMALL COMMUNITIES UNDER
                                  TITLE VI SRFs
      State Revolving Funds (SRFs), established under Title VI of the Clean Water Act as
amended by the Water Quality Act of 1987, are intended to be administered and operated by the
states to provide a permanent source of financing for water quality projects. Nevertheless, SRFs
must meet certain federal requirements specified in the Clean Water Act and written into EPA's
SRF regulations and guidance. These federal requirements currently do not mandate any special
set-asides or eligibility provisions for small communities.  At the same time, federal requirements
do not prohibit such measures. States have the flexibility to incorporate measures targeted to small
communities into their SRF programs.  Some states already have taken into account the needs of
small and/or economically  distressed communities in designing and operating their SRFs.

      Most of the financial assistance provided by  SRFs will  be in the form of loans for
wastewater  treatment facility construction.  Loan repayments provide a continuous  source of
capital to SRFs to provide financial assistance to additional recipients (a key element of their
"revolving" nature). Because of the predominance and integral nature of loan assistance under the
SRF, the Board has focused its attention on die SRF loan program  and its impact on small
communities.
A. STATEMENT OF THE ISSUE

      Although state experience with SRF program implementation is still somewhat limited, the
Board has found mat small communities are experiencing problems under existing SRF loan
programs.  EPA's draft report to Congress on the SRF found that states anticipate difficulty
providing SRF loan assistance to economically distressed and/or small communities because such
communities cannot afford SRF loans at even low interest rates.9  A recent national survey
regarding the impact of SRFs on the ability to finance wastewater treatment projects  in rural,
low-income communities found that nearly all SRF administrators expect some small communities
will be unable to afford SRF loans and that small communities generally will have difficulty
gaining access to SRFs.2*

      The Board has identified four general problems faced by small communities under Title
VI SRFs:

      •     Small communities may not gain priority under the SRF if they must compete
            directly against  larger communities,

      *     Small  communities may  not find affordable financing using SRF loans for
            construction of wastewater treatment facilities,

      •     Small communities may not seek SRF loans because they lack the ability to
            document needs and meet application requirements, and
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       •     Even if SRF financing for capital costs was available, some small communities may
             not be able to afford the 6&M costs of a wastewater treatment facility.

       The Board  has  found that state lending practices are  motivated by several factors in
addition to wastewater facility needs.25 The two most important factors are federal requirements
and the need to maintain the financial integrity of the SRF.  Federal  requirements can affect
lending practices in ways that limit small community access to SRF funds and can increase project
costs, making it difficult to structure an affordable project for small communities.  In developing
their lending policies, states also face trade-offs between providing  interest rate subsidies under
SRFs and maintaining the long-term viability of the fund.  To ensure that the revolving fund is
self-sustaining,  states may be reluctant to issue a large proportion of highly subsidized SRF loans
(i.e.,  at low or zero interest rates) that would  offer affordable financing for small community
needs. The remainder of this section provides additional discussion of these factors and how they
affect small communities.

       SRFs are capitalized initially by EPA capitalization grants and a 20 percent state match.
States must comply with federal requirements (e.g., compliance  with Title n requirements for
equivalency projects and cross-cutting authorities) when issuing loans "directly made available by"
EPA capitalization grants, but are not required to comply with federal requirements when issuing
loans from the  state match or the repayment stream,  or any over-match or  leveraged funds.26
While states currently have  the flexibility to use at least the state match to provide loans mat are
not tied to federal requirements, the Board has found that many states are not aware of this
flexibility. Some states have acted to hasten compliance with federal requirements by accelerating
the distribution  of initial loans tied to EPA capitalization grants. In these states, the majority of
SRF loan funds  are being disbursed as large loans to larger communities, often with incentives to
accelerate loan  repayment schedules.  Such practices restrict small community access to SRFs.

       States that issue bonds to meet the required 20 percent  match or to leverage their SRFs
may need  to encourage the participation of larger communities that can afford the higher interest
rates necessary to  ensure that loan repayments adequately cover  debt service on the bonds.
Leveraging SRFs could possibly help small communities by increasing the total amount of funds
available through the SRF to finance a state's  wastewater facility needs.  On the other hand,
because of the need to charge higher interest rates to meet debt  service requirements, leveraging
could restrict states' flexibility to offer loans at lower interest rates to small and/or economically
distressed communities. Leveraging SRFs also could  more generally restrict small community
access to SRFs because larger communities can be more creditworthy and gaining the participation
of more creditworthy communities enhances the marketability of an SRF loan portfolio to leverage
the fund successfully.

       The principal form of subsidy provided under the SRF is low interest rates for SRF loans.
All states offer SRF loans for the construction of wastewater treatment facilities at below-market
interest rates. Where all communities in a state are eligible for such .interest rate subsidies, small
communities are placed into direct competition with larger communities for low or zero interest
loans.  Small communities find it difficult to compete directly  against larger communities with
greater financial and managerial resources.
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      For some small communities, interest rate subsidies under the SRF loan program (in some
cases, even a zero percent rate) will not reduce the cost of capital enough to make a wastewater
treatment project affordable.  User fees sufficient to repay the loan will not be affordable for these
small communities.  Added project costs from federal requirements contributes to the difficulty
faced by some small communities in developing an affordable project under the SRF.

      Even under the most favorable SRF loan terms (zero percent loans), or alternatively, with
100 percent grant financing, some very small communities would not be able to afford the O&M
costs for a wastewater treatment facility.  These very small communities often were unable to
obtain affordable local share financing under EPA's Construction Grants program and are not
likely to be viable loan candidates under the SRF.  The increasing costs of complying with federal
environmental standards contributes to this problem.

      The Board has observed that while the SRF provides financial assistance for wastewater
treatment projects, small community environmental facility needs also include drinking water and
solid waste management.  As the SRF was established under the Clean-Water Act, it may be
difficult to incorporate a multi-media focus into the SRF loan program. Therefore, the Board also
has examined whether a new multi-media revolving fund exclusively for small communities could
benefit small communities by providing assistance for a broader range of small community needs.
B. DISCUSSION

      Recognizing the problems .facing small communities under the existing SRF program, the
Board has evaluated many options for improving financial assistance to small communities under
Title VI SRFs. These options include changes to the SRF that would enhance the competitiveness
of small  communities under the SRF loan program  and changes  that would improve the
affbrdability of SRF loans for small communities.

      The Board has identified two strategies by which EPA can take a number of actions to
improve financial assistance to small communities under Title VI SRFs.   The first strategy
addresses those actions that will require legislative change to the Clean Water Act and the second
strategy focuses on actions that EPA can take under the existing Title VI SRF to better meet small
community needs. These two strategies are:

      •      The Administrator should consider seeking legislative change to Title VI of the
             Clean Water Act to improve financial assistance to small communities, and

      •      EPA should actively encourage states to give more attention to small community
             needs in their current SRF programs.
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C.  THE  ADMINISTRATOR  SHOULD  CONSIDER SEEKING ADMINISTRATION
SUPPORT FOR LEGISLATIVE CHANGE TO TITLE VI OF THE CLEAN WATER ACT
TO IMPROVE FINANCIAL ASSISTANCE TO SMALL COMMUNITIES

       The Board has concluded that taking action to target a portion of financial assistance
directly to small communities is an important step in addressing small community environmental
facility needs.  The first two actions presented below represent two alternatives for targeting
financial assistance directly to small communities. These two actions are:

       •      Create a small community set-aside under Title VI SRFs, or

       •      Create  a new revolving  fund  exclusively for small  communities  covering
             wastewater treatment, drinking water, and solid waste management.

       A third action to improve the affordability of SRF loans for small communities is:

       •      Extend the SRF loan  term beyond 20 years for small communities.


Create a small community set-aside under Title VI SRFs

       EPA could include set-aside provisions in the SRF program to target financial assistance
directly to small communities. A small community set-aside would create a separate subaccount
within Title VI SRFs for small community needs.  A mandatory small community set-aside would
require a statutory change to Tide VI of the Clean Water Act. Alternatively, a small community
set-aside could be discretionary coupled with financial incentives to encourage SRFs to use it
Because a mandatory set-aside would ensure mat  a fixed proportion of SRF loan funds are
allocated to small  community projects, the Board believes mat this approach is a more secure
means of meeting small community needs.

      There are two ways to require states with SRFs to create a mandatory small community
set-aside. First, states could be given a period of time to establish their own criteria within broad
guidelines established by EPA and create a small community set-aside under their SRF. If not
done by the states, EPA would establish criteria for them and require that the federal criteria be
used to create and award assistance from the small community set-aside.

      EPA or the states would need to develop a  set of criteria to define which communities
would be eligible for financial assistance under a small community set-aside.  First,  it would be
necessary to define "small community" using population-size criteria.  Other eligibility criteria
could determine how states might make financial assistance available  from a small community
set-aside.  Such criteria should be based on an accurate assessment of a community's financial
condition and the ability-to-pay of its residents.- EPA's experience with financial capability and
affordability criteria could serve  as the foundation for  developing such criteria for  a small
community set-aside.

      A precedent does exist for creating mandatory set-asides.  EPA's Title II Construction
Grants program, which is being phased out during the capitalization of the SRF program, included


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  number of mandatory set-asides.  For example, states were required to establish reserves for
 water quality management activities (section 205(j)(l)), nonpoint source management (section
 205(j)(5)), and a reserve of from 4 to 7.5 percent of each state's construction grants allotment to
 provide grants for innovative and alternative technologies. Of greater interest to small community
 concerns, rural states were required to reserve from 4 to 7.5 percent of their construction grants
 allotment for alternative systems for small communities (the rural set-aside).27

       Although not required under the Clean Water Act, at least eight states (Colorado, Florida,
 Kansas, Kentucky, New York, North Carolina, Oregon, and Texas) have established set-asides
 for small community needs within their SRFs."  New York allocates its SRF funds among three
 population size categories with  the category for small communities defined as  less than 3,500
 population.  Each year, New York's SRF funds will be allocated to the three population size
 categories based on their share of total state facility needs.   New York also applies financial
 capability criteria to determine eligibility for lower interest loans.29 In the other seven states,
 SRF set-asides for small communities average 10 percent of total loan funds (or approximately $4
 million). For these set-asides, the definition of a small community ranges from populations of less
 than 3,500 to less than 20,000 persons.

       Four of these states (Florida, Kansas, Oregon, and Texas) have set-asides dedicated to
 small communities regardless of their financial capability. Florida reserves 10 percent of its SRF
 funds for communities of less than 20,000 persons.30  Kansas reserves 10 percent of its yearly
 SRF loans for communities of less than 5,000 persons (representing 92 percent of all communities,
^n the state).31 In Oregon, 15 percent of the SRF funds are set aside for communities of less than
 j',000 persons, although small communities can receive more than 15 percent if dictated by the
 state's priority ranking system.32 Texas divides its communities into population size categories,
 each of which is guaranteed 5 percent of the SRF loans. The state's two categories for smaller
 communities are less than 3,500 and 3,501 to 10,000 persons.31

       A  small community set-aside also could incorporate  special eligibility provisions for
 alternative wastewater treatment technologies  for small communities (i.e., incentives  for
 appropriate-scale solutions) or for separate facility needs (e.g.; septic tank repair or replacement).
 An innovative state program in Washington, for example, sets aside 10 percent of SRF funds for
 on-site system repair and replacement in rural areas under a nonpoint source pollution control
 program.34

 Benefits

       By specifically earmarking a portion of SRF  funds for  small community  needs, a
 mandatory set-aside would help to ensure that small communities have access to the SRF program
 to finance wastewater treatment projects.  The primary advantage of such a set-aside is  its ability
 to target funds directly to small communities, thereby eliminating the need for small communities
 to compete against larger communities for the available SRF funds.

       A single set-aside for small communities would likely provide greater benefits to small
 immunities than an allocation of SRF funds by population size categories.  If such population size
 categories were  allocated funds according to the level of documented facility need in each
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category, both the higher project costs and better documentation of needs for larger communities
could lead to an insufficient share of funds targeted to small communities.

Concerns

       To be most effective in meeting small community wastewater treatment needs, a set-aside
would have to provide a sufficient amount of funds in each state.  This could become even more
important if small communities are not able to get SRF funds from outside of the set-asides once
they are created.  States may voice concern that a mandatory set-aside will reduce their flexibility
in managing SRFs to best meet their particular needs.  However, without specifically earmarking
a portion of SRF funds for small communities, it appears that small communities will continue to
have difficulty competing with larger communities for available funding. States could be given
some flexibility, within broad guidelines, to establish their own definition of a "small community"
to determine eligibility under the set-aside.

       Some small communities may not be able to take advantage of a small community set-aside
unless the SRF loans provided from the set-aside are made more affordable.  Several ways to
improve the affordability of SRF loans are discussed in this Advisory and any of these could be
incorporated into the small community set-aside.

       It must be recognized that SRF loans provided from a small community set-aside may carry
a slightly higher risk of late payments, default, or other loan problems.  States would need to plan
for dealing with such problems, especially if eligibility criteria serve to target a significant portion
of small community set-aside funds to higher risk small community projects.  One way to reduce
such risks would be to provide incentives that encourage appropriate-scale solutions for small
community wastewater treatment.

Sources of Funding

       In creating a mandatory small community set-aside, one of the most significant concerns
is the source of funding for the set-aside.  The Board has considered several sources of funding
at both the federal and state level. These potential funding sources are listed below.

       •      Reallocation of a portion of the authorized appropriations for the SRF to a small
             community set-aside.

       •      Additional appropriations for a small community set-aside.  Under Title Xn of the
             Omnibus Budget Reconciliation Act of 1990, discretionary spending  caps were set
             for FY 1991-1995.  The FY 1991 budget was used as the "benchmark" to forecast
             future spending limits for specific programs.  Authorized appropriations for EPA
             capitalization grants  are  $2.4  billion  in FY 1991.  After  1991,  authorized
             appropriations are scheduled to decrease by $600 million each year to $1.8 billion
             for FY 1992, $1.2 billion for FY 1993, and  $600 million for FY 1994.  Holding
             appropriations constant at $2.4 billion through 199S would yield an additional $6
             billion  from FY 1992-95,  part  of which could  be earmarked for the small
             community set-aside.
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             Additional federal sources of funding.   The Board's  Public Sector Finance
             Advisory  examines several  proposed federal funding sources, including  new
             wastewater effluent charges.

             A higher state match with a portion of the funds allocated to a small community
             set-aside.  For example, the required state match could be raised from 20 percent
             to 25 percent, with the additional 5 percent allocated  to a small community
             set-aside.

             Funds from the SRF repayment stream could be allocated to a small community
             set-aside.

             EPA could encourage states to explore options to  raise additional state funds for
             SRFs that could be used for a small community set-aside.
Create  a new revolving  fund exclusively for  small communities covering  wastewater
treatment, drinking water, and solid waste management

       Another action the Administrator could take to target financial assistance directly to small
communities is to seek Administration support for creating a new revolving fund exclusively for
small communities.35  Small community revolving  funds could be created at the state level to
offer loans at or below market interest rates, including zero interest loans, and to make grants
available to economically distressed small communities to finance environmental facilities.  The
Board believes that a new small community revolving fund should provide such financial assistance
for capital projects for three media — wastewater treatment, drinking water, and solid waste
management.

       Because circumstances across the SO states can be very different, the Board has concluded
that eligibility criteria under a small community revolving fund should be determined by the states
within broad guidelines established by the legislation creating the fund.  The states should have
the flexibility to determine their own population size criteria for defining which small communities
would be eligible for financial assistance from the new revolving funds. Similarly, states should
have the flexibility to chose their own criteria for defining an economically distressed small
community for purposes of grant eligibility.

       Because the provision of grants can deplete  the corpus of the fund  over time, the Board
believes that mere should be a cap on the percentage of overall funds that may be disbursed as
grants.  A cap on grants will prevent the fund from becoming a grant program rather than a
revolving fund.

       The Board maintains that technical assistance should be an integral component of the
financial assistance made available from a new small community revolving fund. Grant recipients,
in particular, should receive technical assistance to ensure the best use of grant funds.
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Benefits

       A  separate revolving fond would have the advantage of targeting financial assistance
directly to small  communities.   By providing financial assistance for wastewater treatment,
drinking water, and solid waste management projects, a new small community revolving fond
would allow small communities the flexibility to address their most pressing environmental facility
needs according to their own priorities.

       The grant component of the proposed fond has obvious benefits to small communities in
that even the most economically distressed small communities can receive financial assistance.
Presently, small communities may not be applying for Title VI SRF loans  because they cannot
afford to pay back a loan even if no interest is charged.  More important,  the grant component
would Kelp ensure  mat the most serious environmental and public health concerns of small
communities are addressed, regardless of a community's financial capability.

       Because the small community revolving fond would  cover drinking water projects, small
communities would benefit if privately-owned public-purpose small facilities were eligible for
financial assistance  from the fond.  The Board has observed that a large proportion of small
drinking water systems are privately-owned, public-purpose  facilities. Creating  a new revolving
fond  provides  an  opportunity  to consider  the benefits  and  implications  of including
privately-owned, public-purpose  facilities as  eligible projects  with regard to better meeting the
drinking water needs of small communities.

Concerns

       Creating a small community revolving fond potentially could result in the exclusion of
small communities from the existing Title VI SRF program. Another concern is that a separate
revolving fond for small communities would not have the flexibility that states  now have under
Title VI SRFs to charge larger projects higher interest rates to provide a larger subsidy to small
or economically distressed communities.

       A major concern regarding the grant component of the proposed fond is the effect that
providing grants would  have on the long-term viability of the new revolving funds.  Without a
repayment stream sufficient to provide a continuous  source of capital,  the  revolving funds
eventually would be depleted over time.  If a large percentage of the funds are disbursed as grants,
the revolving funds eventually would require re-capitalization or they would expire.

       Finally, providing assistance from the new revolving funds for a broad range of projects
- wastewater treatment, drinking water, and solid  waste management - could make it difficult to
address any one of these media thoroughly, given the extent  of small community needs for all
three  media.   However,  because  multiple sources  of financial assistance  exist for small
communities,  the  small community revolving fond would  not be expected to  meet all of the
environmental facility needs of small communities.
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 Sources of Funding

       A source of funding is a significant concern for a new small community revolving fund.
 Because the fund covers three media, it will require an initial capitalization that is sufficient to
 address adequately a broad range of small community needs.  The Board  has considered both
 federal and state funding sources for the new small community revolving fund.  These potential
 funding sources are listed below.

       •      Reallocation of a portion of the authorized appropriations under the Clean Water
              Act to a sub-state revolving fund exclusively for small communities, and amending
              Title VI to allow these funds to be used for wastewater treatment, drinking water,
              and solid waste management.  In FY 1990, Congress authorized the state of Texas
              to establish a special revolving fund for colonias,  the small communities along the
              international border with Mexico.  This special revolving fund was capitalized from
              the construction grant allotment for Texas.

       •      Additional  appropriations for a new small community revolving fund.

       •      Other  federal funding sources.  The Board's Public Sector Finance Advisory
              examines several proposed federal funding sources for different media, including
              new user fees and effluent charges. These funding sources are examined in the
              context of a proposed financing mechanism, an Environmental  Trust, that would
              provide hardship grants to fund the provision of local environmental services in
              drinking water, wastewater treatment, and solid waste management.

       •      A  state match that could  be set, for  example, at 25  percent of the federal
              capitalization grants made available for the new small community revolving funds.

       •      States  could be given  incentives to raise additional state funds that could be used
              for the new small community  revolving  funds.
 Extend the SRF loan term beyond 20 years for small communities

       Extending amortization periods for SRF loans awarded to small communities could help
 reduce annual debt service.  The Board believes that the SRF loan term should be extended up to
 40 years for small communities, as long as the loan term does not exceed the  design life of a
 facility.  Because the Clean Water Act presently requires that loans awarded from SRFs be fully
 amortized not later man 20 years after project completion, a statutory change would be necessary
 to allow states to extend the amortization period beyond 20 years.  Alternatively, an extended loan
 term could be incorporated into the new small community revolving fund, if created.

       As an alternative or in addition to extending the loan term, small communities also could
vbenefit from deferred loan repayments, for example, for up to 3 years after project completion.
 fhis practice does not reduce the total amount to be repaid, but pushes back  repayments  for
 several years allowing a community to enjoy a grace period. This, too, would require a statutory
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change to the Clean Water Act, as the Act presently requires that annual loan repayments begin
no later than one year after project completion.

Benefits

       Extending the SRF loan term would increase the affordability of SRF financing for small
communities by lowering annual debt service.  Lower annual loan repayments would especially
benefit those small communities in weak financial condition.   The SRF also may benefit by
reducing potential loan problems, such as late payments or defaults.  -

Concerns

       It would be difficult to justify extending the loan term beyond the design life of a facility.
Generally, the term of a loan is linked to the useful life of the facility or improvement financed
by the loan.  When loan repayments are backed by user charges, this practice helps to ensure that
loan payments will continue to be made until the entire debt is repaid.

       The design life of a wastewater treatment facility can be up to 30 years. Extending the
loan term up to 30 years in such cases would lower annual debt service for the community.
Because collector systems can represent a large proportion of total wastewater project costs for
small  communities and typically have a 40-year design life, this component of small community
wastewater needs may be best suited to extended amortization periods.
D. EPA SHOULD ACTIVELY ENCOURAGE STATES TO GIVE MORE ATTENTION TO
SMALL COMMUNITY NEEDS IN THEIR CURRENT SRF PROGRAMS

      The Board has concluded that mere are a number  of actions that would improve the
affordability of SRF loans for small communities.  Other actions would broaden the range of
financial assistance available to small communities from SRFs.  The states currently have the
flexibility to implement any of the following actions under their SRFs.  These actions are:

      •      Vary interest rates based on ability-to-pay or  other measures of economic need,

      •      Provide supplemental state grants for hardship cases,

      •      Allow subsidization of principal for loans made from the repayment stream,

      »      Mitigate federal requirements for small communities,

      •      Provide guarantees for small community debt, and

      •      Provide technical assistance to small communities.
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 'ary interest rates based on ability-to-pay or other measures of economic need

       The ability of states to provide interest rate subsidies (i.e., below-market interest rates) on
 SRF loans is one approach to addressing small community financial capability problems. Because
 the interest rate charged on SRF loans can have a significant impact on user charges, low or zero
 interest rates can improve the affbrdability of SRF financing (see Appendix C for an affordability
 analysis of SRF loan financing).

       As the Clean Water Act already authorizes SRF interest rate subsidies, EPA can act now
 to encourage states to offer interest rate subsidies for small or low-income communities.  If a
 small community set-aside is created under the SRF, interest rate subsidies should be incorporated
 as part of the set-aside. Subsidized interest rates also should be incorporated under the new small
 community revolving fund, if created.

       The SRF was established to allow states the flexibility to offer interest rate subsidies.
 Subsidized interest rates are being provided under SRFs for at least two reasons.  First, because
 federal requirements increase project costs for SRF loan recipients, states have found mat  a
 subsidized interest rate is necessary to make the SRF loan program attractive to communities.
 Thus, one reason that states are offering SRF loans at below-market interest rates is to offset the
 added project costs of meeting federal requirements. Some analyses have estimated that an interest
 rate subsidy of 2 to 3 percent below the market rate is necessary to offset these added project
 costs.96 Second, some states offer an additional interest rate subsidy (as low as a zero percent
>ate) to meet the needs of small and/or low-income communities.

       A  recent survey  of SRFs37 found  that  12 states  (Delaware,  Kentucky, Maryland,
 Minnesota, Montana, Nebraska, New York, Pennsylvania, Tennessee, Utah, Virginia, and West
 Virginia) offer SRF loans at interest rates on a sliding scale to as low as zero percent based on
 ability-to-pay. Fixed "hardship" interest rates (typically 0 percent, but ranging up to 2 percent
 for some states) for facilities hi economically  distressed areas are offered in Minnesota, New
 Mexico, Ohio, Pennsylvania, South Carolina, Texas, Vermont, and Washington.

 Benefits

       Interest rate subsidies on SRF loans are an effective way to structure affordable financing
 for some small communities.  Lowering the interest rate can have a significant effect by lowering
 the interest payments on the loan, which lowers  the  overall  capital financing costs for the
 community.  With lower capital costs for its wastewater treatment facility, a community1 can keep
 user fees at affordable levels.

       Eligibility criteria could  target the level of the SRF interest rate subsidy to the severity of
 the financial capability problems faced by a community. Some states already have established
 eligibility criteria mat could serve as examples to other states that chose to incorporate interest
 rates based on ability-to-pay into their SRF loan programs.
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Concerns

       There is a trade-off between the long-term viability of a revolving loan fund and the level
of subsidy offered to local communities.  If a large proportion of loans are awarded at highly
subsidized interest rates, a revolving loan fund  will be depleted over time.  Lending  policies
should be evaluated in terms of their effect on the self-sufficiency of the SRF program.

       When evaluating the affbrdability of a wastewater treatment project,  it is important to
realize mat the SRF subsidizes only the capital portion of a community's wastewater facility costs.
O&M costs can represent a large proportion of the total costs of a wastewater treatment facility.
For some small communities with financial capability problems, the O&M costs alone could make
a wastewater treatment project unaffbrdable. O&M costs must be examined as closely as capital
financing costs to evaluate whether a small community could benefit from an SRF interest rate
subsidy.  Choosing an affordable treatment technology  from the standpoint  of O&M  costs is
important to the success of small community projects.

       SRF  interest rate subsidies will  not help all small communities.  Low-income small
communities may not  find affordable financing using the SRF even with a zero interest loan.
Where the necessary increase in user fees or the need to implement user fees for the first time is
subject to voter  approval, it may be difficult to raise user fees high enough to repay the loan. In
certain hardship cases, communities may need additional financial assistance to meet their
wastewater treatment needs.
Provide supplemental state grants for hardship cases

       Communities with very low household incomes and communities located in economically
distressed areas with high unemployment rates will have the most serious financial capability
problems. Those communities with the greatest financial need could be characterized as hardship
cases.  Hardship cases generally will not be able to afford SRF financing without additional
financial assistance.  Some, but not all, hardship cases will be small communities. Supplemental
grants are one way to provide the additional financial assistance these communities will require
to meet their wastewater treatment needs.  The new small community revolving fund, described
above, would be created with a grant component for economically distressed small communities.

       The Clean Water Act currently prohibits states from providing grants with funds  from the
SRF. Hence, a statutory change to Title VI of the Clean Water Act would be necessary if grants
were to be provided from SRFs.  Such a change is unlikely to occur as the SRF program  is
intended to be a transition from a grant program (i.e., the Construction Grants program  in which
federal grants were awarded to local governments by EPA, but most program activities were
delegated to the states) to a loan program.  Grant assistance for hardship cases in conjunction with
the SRF, therefore,  will most likely be in the form of state grants from other state funding
sources.  One alternative for states is to provide such grant assistance through an over-match  to
the SRF.

       At least 19 states currently offer supplemental funding in the form of grants or low-interest
loans targeted to small or low-income communities for wastewater projects.  These supplemental


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   inds are raised from other state revenue sources. Some states combine supplemental state grants
  tvith SRF loans to increase the affordability of an SRF loan for the community.  Of die 19 states,
  eight states target funds to small, low-income communities, five states target funds to small
  communities, and six states target funds to low-income communities.38
                      i
        In addition to grant assistance for construction of wastewater treatment facilities, planning
  grants could be provided to help small communities document their needs and serve as an incentive
  for small communities to participate in the SRF loan program.  Some very small communities may
  not be able to afford the up-front costs of applying for SRF loans. Federal requirements under
  the SRF  specify  that facility  plans, environmental  impact  statements, and  water  quality
  management plans be completed prior to loan approval.  These requirements add to die overall
  project costs of facilities constructed with SRF financing. Without additional financial assistance
  to cover the costs of preliminary planning and design requirements, some small communities may
  not have the ability to seek SRF loan assistance for their wastewater facility needs. At least six
  states currently offer planning and/or design grants to  low-income small communities.39

  Benefits

        Supplemental grants may be the only way to package affordable financing for wastewater
  treatment facility construction for hardship  cases.  This additional  level of subsidy could be
  targeted first to hardship cases with serious environmental or public health problems. In this way,
  the greatest benefits could be obtained from the limited resources available to provide state grants.

  Concerns

        States may have difficulty expanding existing state grant programs or establishing new
  grant programs because of the serious strain that such programs can place on state resources.
  EPA may need to find ways to provide incentives that would encourage states to provide such
  grant assistance.

  Sources of Funding

        States will need to find their own funding sources for grant assistance to combine with SRF
  loans or to offer as a separate state grant program.  EPA could encourage states with existing
  grant programs to share information regarding how they have successfully  raised such funds.
  These additional state funds for supplemental grant assistance could be provided as an over-match
  to the SRF.
 Allow subsidization of principal for loans made from the repayment stream

        Subsidization  of principal  on SRF loans is another  option  that could benefit  small
 communities. The SRF could write down up to 100 percent of the principal to be repaid  on an
NSRF loan, effectively providing subsidization of principal along with subsidized interest Because
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subsidization of principal can improve th&affordability of SRF loans, the Board has concluded that
this option merits further investigation.

       The Board believes that subsidization of principal should be tied to certain conditions, such
as a good compliance record or the use of innovative or appropriate technologies to provide
cost-effective wastewater treatment for small communities. Principal write-downs should come
into effect only if a small community meets such conditions, thus providing an incentive for
responsible facility planning and management.

Benefits

       Some small communities have serious environmental or public health concerns, yet are not
able to afford an SRF loan even at zero percent interest   These communities may be forced to
forego construction of a needed wastewater treatment facility if a greater level of subsidy is not
available. Principal write-downs could  provide this additional subsidy under the existing SRF
program.

       Subsidization of principal would allow a community to keep user fees at affordable levels
because the SRF would subsidize debt service costs.  The  community, however, should be
required to set user fees high enough to cover operation and maintenance costs and to build up a
reserve that would pay for future capital improvements.

Concerns

       Allowing subsidization of principal would tend to make some SRF loans become much like
grants. By limiting principal write-downs to small communities, only the smaller loans from the
SRF would  be eligible  for this additional subsidy.   States also may want to  limit  principal
write-downs to hardship cases facing serious environmental and public health problems.

       Subsidizing the principal on SRF loans would reduce the repayment stream, which is the
source of capital to maintain the long-term viability of SRFs.   States that offer  principal
write-downs would see their funds depleted over time unless some mechanism is put in place to
raise additional funds  or charge larger  projects higher interest  rates  to provide an additional
subsidy to hardship cases,
Mitigate federal requirements for jan^il communities

       The Board has observed that some states are  not aware that they currently have the
flexibility to provide SRF loans mat are not subject to federal requirements.  Because federal
requirements add to project costs, meeting these requirements can make an SRF loan unaffbrdable
for some small communities. These federal requirements include Title n equivalency requirements
and cross cutting authorities.  The Board's Public Sector Finance Advisory also examines the
impact of these federal requirements on SRF loan financing for local governments.
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       States must comply with Title II equivalency requirements when issuing loans "directly
made available by" EPA capitalization grants.   These "equivalency requirements" are the 16
specific statutory requirements that section 602(b)(6) of the Clean Water Act attaches to section
212 publicly-owned treatment works projects constructed "in whole or in part before FY 1995."
These equivalency requirements include labor  wage provisions of the Davis-Bacon Act  and
environmental impact statements as required by the National Environmental Policy Act (NEPA).

       Cross cutting authorities are those federal laws and authorities that are applicable to all
projects or activities receiving federal financial assistance, regardless of whether the statute
authorizing the assistance makes them applicable. These federal cross cutters include the Civil
Rights Act of 1964, requirements for the participation of minority- and women-owned businesses,
and a number of federal environmental laws and Executive Orders.  Under the SRF, federal cross
cutters apply to projects  assisted with funds "directly  made available by" EPA  capitalization
grants.

       Because equivalency requirements and cross cutting authorities apply only when issuing
SRF loans "directly made available by" EPA capitalization grants, they do not apply when issuing
loans from the state match or the repayment stream, or any over-match or leveraged funds. States
can chose not to subject small community projects to equivalency requirements or cross cutting
authorities when making SRF loans from these other funding sources.

Benefits

       Providing SRF loans to small communities from funds that are not tied to compliance with
federal  requirements can  avoid subjecting small communities to the added costs  of these
requirements, thus making SRF loans more affordable for small  communities. More important,
if small community projects are not subject to the added costs of federal requirements, the entire
subsidy offered under the SRF can go to  offset real project costs.

Concerns

       Some communities may have chosen not to seek SRF loans because of misconceptions
regarding  compliance with federal requirements. States should educate their local communities
about these issues through outreach efforts, as needed, so that communities are not avoiding the
SRF unnecessarily due to apprehension about the additional costs of meeting federal requirements.
Provide guarantees for small community debt

       One type of financial assistance authorized under the SRF is providing guarantees for local
debt obligations where such action would improve credit market access or reduce interest rates.
SRFs also can purchase or provide bond  insurance to guarantee debt service payment.  Bond
insurance is available from a number of commercial insurance companies.   The Board  has
concluded that states can act to improve debt financing opportunities for small communities by
using their SRFs to provide guarantees for small community debt.
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Benefits

       Some small communities may wish to issue debt to finance wastewater treatment facilities,
but may be constrained by lack of access to the capital markets or by higher interest rates charged
for small debt issues. Using the SRF to provide guarantees for small community debt serves as
a credit enhancement and can lower debt financing costs for small communities.

Concerns

       Using an SRF to guarantee or purchase insurance for local debt obligations would involve
spending SRF funds without a repayment stream and thus would have some effect on the corpus
of tfte fund.  To offset this concern, SRFs could charge a  "premium*  for providing bond
insurance, but this would increase the costs of offering this type of financial assistance to small
communities.
Provide tuchwimi assistance to spiall communities

       Technical assistance has long been recognized as an important mechanism for helping small
communities meet  their environmental facility needs.   Technical assistance could help small
communities gam access to SRFs.  Lack of information and inability to properly document facility
needs are major reasons why some small communities are not taking advantage of the SRF
program.  Because technical assistance also has an important role in improving the performance
of small environmental facilities, providing such assistance could benefit small communities by
lowering O&M costs.

       Technical assistance can be made available for planning, design, financing, construction,
management, and operation and maintenance of wastewater treatment facilities.  At least four
states (Alaska, Minnesota, Wisconsin, and Vermont) currently provide technical assistance in
conjunction with their SRFs for the purpose of correcting O&M problems.40 Technical assistance
is particularly important if supplemental grant assistance is provided to ensure the best use of
limited grant funds.

       The Board believes that technical assistance should be designed to encourage the adoption
of cost-effective technologies for small community environmental facilities. Lower cost technical
solutions can  play an important  role  hi improving  the affordability of small community
environmental infrastructure projects by lowering the capital costs of constructing a facility.
                                                                              Page 36

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                                       NOTES

 1.     Office of Policy,  Planning, and Evaluation, U.S. Environmental Protection Agency,
       Environmental Investments: The Cost of a Clean Environment,  EPA 230-11-90-083
       (November 1990), 9-4, 8-51.  Total annualized costs are presented in 1986 dollars and
       include capital costs annualized at 7 percent and operating costs for implementing existing
       and new regulations under the present implementation scenario.

 2.     Apogee Research, Inc. and Wade Miller Associates,  Inc.,  "Problems in Financing and
       Managing Smaller Public Works," prepared for the National Council on Public Works
       Improvement (September 1987), 5, 12.

 3.     National Council on  Public Works  Improvement, Fragile Foundations: A Report on
       America's Public Works (February 1988),  100-101.

 4.     Office of Technology Assessment, U.S. Congress, Rebuilding the Foundations: A Special
       Report on State and Local Public Works Financing  and Management, OTA-SET-447
       (Washington, DC: U.S. Government Printing Office, March 1990), 116-117.

 5.     Office of Administration and Resources Management, U.S. Environmental Protection
       Agency, A Preliminary Analysis of the Public  Costs of Environmental  Protection:
       1981-2000 (May 1990), 27, 29-30.  All costs are presented in 1988 dollars.
 K
 >.     Office of Policy, Planning, and Evaluation, Environmental Investments, 4-13, 5-12.

 7.     Personal communication with A. W.  Marks, EPA Office of Ground Water and Drinking
       Water,  June 27,  1991.   Also  see  Office  of Policy,  Planning,  and  Evaluation,
       Environmental Investments, F-18.

 8.     These assumptions were calculated using data from EPA's Municipal Sector Study. See
       Office of Policy, Planning, and Evaluation, U.S. Environmental Protection Agency, The
       Municipal Sector Study: Impacts of Environmental Regulation  an Municipalities,  EPA
       230-09/88-038 (September 1988), III-3,  IH-8.

 9.     Office of Policy, Planning, and Evaluation, The Municipal Sector Study, ix.

 10.    Testimony of Robert H. Wayland,  Deputy Assistant  Administrator  for Water,  U.S.
       Environmental Protection Agency, before the U.S. Senate Committee on Environment and
       Public Works, May IS, 1990.  As defined by EPA's Office of Drinking Water, a
       community drinking water system provides piped water to 25 or more permanent residents
       and/or 15 residential service connections.

 11.    Council of  Infrastructure  Financing Authorities, "Small Community Infrastructure:
       Subsidies in Transition," (October 1989), 3-5.

12.    Bureau  of the Census,  U.S.  Department of Commerce, 1980 Census of Population:
       Number of Inhabitants,  United States Summary,  PC80-1-A1  (Washington, DC:  U.S.
       Government  Printing  Office, April 1983), 36-37.  The Bureau of the Census has not
       released 1990 population data by size of place.

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 13.    Bureau of the Census, 1980 Census of Population, 59-60.

 14.    Personal  communication with Terry Kuhlman, Minnesota  Department of Trade  and
       Economic Development, March 29, 1991.

 IS.    Personal  communication with Dan Filip, Washington Department of Ecology, Water
       Quality Financial Assistance Program, March 29, 1991.

 16.    Joni  L. Leithe,  "State Bond Banks,"  Credit  Pooling  to Finance Infrastructure: An
       Examination of State Bond Banks, State Revolving Funds, and Substate Credit Pools,
       (Government Finance Officers Association, September 1988), 24-34; and  Chambers
       Associates, Inc.,  "State Infrastructure Banks," prepared  for the National Association of
       Home Builders Task Force on Infrastructure (September 1988).

 17.    Personal  communication with state bond  bank officials in Alaska,  Indiana, Maine,
       Michigan, and New Hampshire; and Leithe, "State Bond Banks," 24-55.

 18.    Personal communication with Lana Lutringer, Texas Water Development Board, March
       1991; and materials provided by the Texas Water Development Board.

 19.    Office of Water,  U.S. Environmental  Protection Agency,  Reference Guide on State
       Financial Assistance Programs, EPA 430/09-88-0004 (February 1988), 25-29.

 20.    Personal communication with Robert Lenna, Executive Director, Maine Municipal Bond
       Bank, April 12,1991; and Cathy Robinson, Maine Municipal Bond Bank, April 26,1991.

 21.    Leithe, "State Bond Banks,' 31-33; and Office of Water, Reference Guide, 21, 28.

 22.    Personal communication with Michael Curley, Heartland Resources, Inc., June 19, 1991.

 23.    Office of Municipal Pollution Control, U.S. Environmental Protection Agency, State
       Revolving Fund (SRF) Final Report to Congress: Financial Status and Operations of Water
       Pollution Control Revolving Funds (May 1991 draft), 6-7, 11-1.

 24.    The Center for Community Change, Through the Revolving Door: An Analysis of Rural
       Wastewater Financing (Washington, DC: The Aspen Institute, forthcoming).

 25.    Several sources were used,  including  Office  of Municipal Pollution Control, State
       Revolving Fond (SRF) Final Report to Congress; The Center for Community Change,
       Through the Revolving Door, and personal  communication with  SRF program staff in
       various states.

 26.    See Office of Municipal Pollution Control, U.S. Environmental Protection Agency, Initial
       Guidance for State Revolving Funds (January 1988), 11-18.

27.    Office of Municipal Pollution Control, Initial Guidance for State Revolving Funds, C-5.

28.    The Center for Community Change, Through the Revolving Door.
                                                                              Page 38

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19.    Personal communication with Jerry .purr,  New York  State Environmental Facilities
       Corporation, March 1991.

30.    Personal communication  with Jim Watson,  Florida  Department  of Environmental
       Regulation, March 1991.

31.    Personal communication with Rod Geisler, Kansas Department of Health and Environment,
       March 28, 1991.

32.    Personal communication with Martin Loring, Oregon  Department of Environmental
       Quality, March 25, 1991.

33.    Personal communication with Kevin Ward, Texas Water Development Board, March 22,
       1991.

34.    The Center for Community Change, Through the Revolving Door.

35.    Title I of the "Small Community Environmental  Infrastructure Assistance Act of 1990"
       (S.729), introduced in the 102nd Congress, contains provisions for sdch a fund. The Act,
       which previously was introduced in the 101st Congress, would establish revolving funds
       at the  state level to help small communities finance capital projects for wastewater
       treatment, drinking water, and solid waste management through a combination of grants
       and loans at or below market interest rates.

36.    Office  of Municipal  Pollution Control, State Revolving Fund  (SRF) Final Report to
       Congress, 6-4.

37.    The Center for Community Change, Through the Revolving Door.

38.    The Center for Community Change, Through the Revolving Door.

39.    The Center for Community Change, Through the Revolving Door.

40.    The Center for Community Change, Through the Revolving Door.
                                                                             Page 39

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                                   APPENDIX A
           SMALL COMMUNITY FINANCIAL ASSISTANCE PROGRAMS
      The Board examined a number of programs that provide financial assistance to small or
low-income communities or rural areas for environmental infrastructure projects.  Six federal,
regional, or  state-administered programs as well as CoBank, a federally chartered financial
institution with an important role in rural areas,  were examined in some detail. Appendix A
provides brief descriptions of the following small  community financial assistance programs:

      •      State Revolving Fund (SRF) Program,

      •      Water  and Waste  Disposal  Loan  and  Grant  Program  — Farmers Home
             Administration,

      •      Public Works and Development Facilities Grant Program — Economic Development
             Administration,

      •      Community Development Block Grants/Small Cities Program —  Department of
             Housing and Urban Development,

      •      Partners for Environmental Progress Initiative — U.S. Army Corps of Engineers,

      •      Appalachian Regional Commission  Supplemental Grants, and

      •      CoBank, the National Bank for Cooperatives.


State Revolving Fund (SRF) Program

      Title VI of the Clean Water Act, as amended by the Water Quality Act of 1987, authorizes
the U.S. Environmental Protection Agency (EPA)  to award capitalization grants to states for the
purpose of establishing state revolving funds (SRFs).1  SRFs are intended to be permanent state
institutions to provide a continuous  source of funding for water pollution control facilities and
programs. States also must contribute to the capitalization of their SRFs by providing at least a
20 percent state match for each EPA capitalization grant  The state match can be derived from
a variety of funding sources,  including legislative  appropriations, proceeds from state bonds, or
dedicated state taxes.

      From the SRF, states  may provide loans and other types of financial assistance, but may
not provide  grants, to municipalities,  intermunicipal,  interstate,  or state agencies  for  the
construction of publicly-owned wastewater treatment facilities, for the implementation of nonpoint
source pollution control programs, and for the  development and implementation  of estuary
management  programs. Once capitalized, each SRF is administered and operated by the state,
however, states must meet certain federal requirements specified in EPA's  SRF regulations and
guidance.  The SRF program is fashioned to allow states the maximum flexibility to design and
operate SRFs to meet the particular  needs and circumstances of each state.


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       Seven general types of financial assistance are authorized under SRFs.  Using funds from
an SRF, states may: (1)  award loans at or below market interest rates or for zero interest,
(2) purchase or refinance existing local debt obligations at or below market rates, (3) guarantee
local debt obligations where such action would improve credit market access or reduce interest
rates, (4) guarantee SRF  debt obligations, that is, secure state bond issues  provided that the
proceeds are deposited in  the SRF, (5) provide loan guarantees for "sub-state revolving funds,"
(6) earn interest on SRF accounts, and (7) support SRF administrative expenses.

       SRFs are established primarily to award loans to local governments.  Loan repayments
provide a continuous source of capital to SRFs to make  loans to additional recipients.  Because
states are responsible for determining interest rates for SRF loans, each state has the flexibility to
set interest rates according to the financial needs of individual communities.

       During implementation of the SRF program, EPA's Construction Grants program is being
phased out Funding for the Construction Grants program ended in FY 1990.  The Water Quality
Act of 1987 authorizes EPA's SRF  Capitalization Grant program through 1994.  Authorized
appropriations for the SRF Capitalization Grant program were $1.2 billion for both FY 1989 and
FY 1990, $2.4 billion for FY  1991, $1.8 billion for FY 1992, $1.2 billion for FY 1993, and $600
million for FY 1994. In FY  1991, EPA allocated $2 billion for SRF capitalization grants from
the total Congressional appropriation  for the SRF of $2.1 billion (see Table A-l).
Water and Waste Disposal Loan and Grant Program — Farmers Home Administration

       The Fanners Home Administration (FmHA) Water and Waste Disposal Loan and Grant
Program provides financial assistance for the installation, repair, improvement, or expansion of
water systems, wastewater collection and treatment systems, and solid waste disposal facilities.2
The facility must primarily serve a rural area or communities of less than  10,000 population.
Most of the funded projects involve water or wastewater systems. FmHA assistance is available
to municipalities, counties, and other political subdivisions of a state, including special purpose
districts and authorities, associations, cooperatives, and nonprofit organizations. Applicants must
demonstrate that they are unable to finance the proposed project from their own resources or
through commercial  credit at reasonable rates and terms.

       FmHA Water and Waste Disposal funds are allocated among the states based on each
state's percentage of the total U.S. rural population and the state's percentage of the total U.S.
rural population living below the poverty level.  The program is administered primarily through
FmHA's network of state and  district offices.  Criteria for awarding assistance takes explicit
account of a community's financial capability in determining the type of assistance to be provided.
The program has no matching requirements and provides three types of financial assistance: loans,
grants, and loan guarantees.
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           Table A-l. Spending History for .Selected Federal Assistance Programs
Spending by
Federal
Agency
EPA:
Construction Grants
SRF Capitalization Grants
FmHA:
Loans
Grants
Loan Guarantees
EDA Grants*
HUD:
CDBG Small Cities Grants*
ARC Supplemental
Grants*
Federal Agency, for Selected Years from 1981-1990
(in millions of current dollars)
FY1981
$3,942
750
210
221
NA
34
Obligations
FY1984 FY1987
$3,717
270
104
116
910
24
$2,169
330
118
99
742
18
FY1990
$1,040
1,344
350
212
0
110
838
26
/^JlilJj-m.jujjxii.^l
congressional
FY1991
$2,047
500
300
35
141
944
NA
Notes:

EPA - Data from EPA budget justifications for FY 1983, 1986, 1989, and 1992. Data for FY 1991
represents the SRF capitalization grant allocation from the total $2.1 billion SRF appropriation, with
the remainder allocated to several projects authorized under the Clean Water Act.

FmHA - Data provided by Nolan Kegley, Information Specialist, Legislative Affairs and Public
Information Start, FmHA.

EDA - Data provided by Margaret Boyd, Public Works Division, EDA.

HUD - Data for FY 1984 and 1987 from HUD's  1989 report to Congress on community
development programs (includes state CDBG small cities grants only). Data for FY 1990 and 1991
from HUD's FY 1992 budget justification (includes slate and HUD-administered CDBG small cities
grants).

ARC — Data provided by Ann Anderson, Director of Public Affairs, ARC, from ARC annual reports.

* Water and wastewater projects represent a portion of the total spending reported above.

NA = Data not available at the time of preparation.
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       FmHA provides loans at three interest rates: market-rate loans, intermediate-rate loans
 (i.e., halfway between 5 percent and the market rate), and 5 percent loans. Applicants can quality
 for the 5 percent rate when the loan is needed to meet a health or sanitary standard and the median
 household income of the service area is below the poverty level.  Applicants can qualify for the
 intermediate rate when the median household  income of the service area  is less man the
 nonmetropolitan median household income for the state.  The maximum loan term is 40 years,
 however, the term may not exceed the useful life of the facility.

       Grants are made only when necessary to reduce user charges to a reasonable level.  To
 qualify for  a grant of up  to 75  percent of eligible project costs,  the  service area's median
 household  income  must be below the poverty level or below  80  percent of the state's
 nonmetropolitan median household income (whichever is higher). If the service area has a median
 household income between  80 and 100 percent of the state's nonmetropolitan median household
 income, a proposed project can qualify for a grant of up to 55 percent of eligible costs. Grant
 eligibility also depends on whether a project's annual debt service costs on a per-user basis exceeds
 a specified percentage  of the median household income of the service area.  These  additional
 criteria are that annual debt service costs must exceed 0.5 percent of median household income
 to be eligible for the 75 percent grant and 1 percent of median household income to be eligible
 for the 55 percent grant.

       A third source of financial assistance — loan guarantees — was added in FY1990.  FmHA
 can guarantee third-party loans for between 80 and 90 percent of eligible project costs. Eligibility
. criteria are the same as for the loan program described  above.

       Throughout the 1980s, obligations for FmHA's loan program have varied between $750
 million for FY 1981 and $270 million for FY 1984 (see Table A-l).   Obligations were at a level
 of $350 million in FY 1990.  The Congressional appropriation for FY 1991  is $500 million.
 FmHA's grant program obligations were $104 million in FY 1984, but have since increased to as
 much as $212 million in FY 1990.  For FY 1991, the Congressional appropriation is $300 million
 for the grant program.  The loan guarantee program had a Congressional appropriation of $75
 million in its first year, FY 1990, but no loan guarantees were made under the Water and Waste
 Disposal Program. The Congressional appropriation for the loan guarantee program is $35 million
 for FY 1991.

       Title 23 of the Food, Agriculture, Conservation, and Trade Act of 1990 Q.e., the 1990
 Farm Bill) created the Rural Development Administration (RDA) within the  U.S. Department of
 Agriculture.  The Act also requires the transfer of certain FmHA functions,  including  the Water
 and Waste Disposal Loan and Grant Program, to RDA. While planning currently  is  underway
 to establish the RDA, create a field structure, and ultimately transfer certain FmHA functions, the
 initial changes are not expected until after October 1, 1991.  As the transfer of functions will be
 phased in and will take some time to complete, it is difficult to assess the impact of these changes
 until more information  is available from the newly created RDA.
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Tublic  Works and Development Facilities Grant  Program - Economic  Development
Administration

       EDA awards grants to finance construction of public works and development facilities to
promote long-term economic  development and contribute to  private-sector job  creation and
retention in areas experiencing severe economic distress. Water and wastewater treatment systems
are among the types of projects eligible for grant assistance tinder EDA's Public Works and
Development Facilities Grant Program.3

       Eligible applicants  include state and  local governments  as well as private or public
nonprofit organizations or associations representing a redevelopment area or an EDA-designated
Economic Development Center.  Nonprofit applicants are urged to seek the cooperation and
support of units of local government and, when deemed appropriate by EDA, to have the local
government serve as co-applicant for EDA grant assistance.

       On the average, EDA grants cover approximately SO percent of project costs.  Priority is
given to applications mat maximize the local share of project costs as  evidence of firm  local
commitment to a proposed project  Areas experiencing severe economic distress are eligible for
supplementary grant assistance of up to 80 percent of the project cost

       Obligations for EDA's public works  program  were  $221 million in FY 1981  and
$110 million  in FY 1990 (see Table A-l).  The Congressional appropriation for FY 1991 is
^$141 million.
 Community Development Block Grants/Small Cities Program - Department of Housing and
 Urban Development

       HUD administers the Community Development Block Grants/Small Cities Program as one
 component of its Community Development Block Grant (CDBG) funds.4 Small Cities funds can
 be used to provide grants for activities that benefit low- and moderate-income people and improve
 living conditions and economic opportunities in urban communities. The funds sometimes are used
 to construct public facilities, including water and sewer systems.  States may elect to administer
 the Small Cities program and all states have done so except New York and Hawaii.  HUD
 continues to administer the Small Cities program for those two states.

       Each state that administers the Small Cities program receives a block grant, with funds
 allocated among the states using a needs-based formula that includes population  as well as the
 extent of poverty and poor housing conditions. Most states administer this program through their
 departments of economic and community development  States distribute the funds to units of local
 government in areas mat do not receive CDBG entitlement grants (eligibility for CDBG entitlement
 grants generally includes metropolitan cities of at least 50,000 population and urban counties of
 at least 200,000 population).  Each state develops its own administrative procedures, funding
 priorities, and selection criteria, although HUD requires that at least 60 percent of the  funds be
 used to benefit low- and moderate-income persons.
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       During the 1980s, obligations for CDBG small cities grants were as high as $910 million
in FY  1984 (see Table A-l). The Congressional appropriation for FY 1991 is $944 million.
Partners for Environmental Progress Initiative — U.S. Army Corps of Engineers

       The 1991 appropriations for the U.'S. Army Corps of Engineers (Corps) authorized funds
for a new initiative called "Partners for Environmental Progress" (PEP).5 PEP is oriented to
smaller communities or  those without significant resources, and  is  intended to help such
communities find ways to privatize environmental services.  Currently, the primary focus of PEP
is market feasibility studies.  The Corps plans to  issue guidance to its Divisions and District
Offices regarding these market feasibility studies.

       Market feasibility studies involve putting together a database so the private sector can
evaluate the revenues and costs of providing particular environmental services to a community.
With this information, a community  will be prepared  to talk  to the  private sector about
privatization opportunities. The Corps is designing PEP to complement EPA's efforts to examine
ways that the private sector, can  provide environmental  services (i.e., EPA's Public-Private
Partnerships initiative). PEP will get a community to  the point where it is  prepared to approach
the private sector and EPA will help the community  evaluate alternative ways that the private
sector can participate in providing  environmental services.

       The Corps expects to spend around $200,000 for PEP in FY 1991.  The Corps presently
plans to set a $50,000 federal limit for each market feasibility study.  Participating communities
must provide a local share equal to SO percent of the costs.  In 1991, the Corps plans to ask
participating communities to provide the SO percent local share by performing in-kind services.
The success of the pilot projects funded in 1991 will determine the future policy direction of the
PEP initiative.
Appalachian Regional Commission Supplemental Grants

       The Appalachian Regional Commission (ARC) supplemental grants program awards grants
to assist in improving the creation of jobs and private sector involvement and investment by
funding development facilities.  Eligible development facilities include water and wastewater
systems as well as the development of industrial sites.  Generally, these ARC grants are used to
provide supplemental funds under other federal grant-in-aid programs. ARC supplemental grant
funds are available only for projects that conform to state Appalachian development plans and only
for specified Appalachian counties.

       States, their subdivisions and instrumentalities, and private nonprofit agencies that apply
through the state are eligible for the supplemental grants.  The program awards grants of up to
SO percent of total project costs.  In "distressed counties," grants may be awarded for up to 80
percent of total project costs.  At least 20 percent of the eligible development costs must be
obtained from sources other than the federal government
                                                                              Page A-6

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       Obligations for ARC supplemental grants were $34 million  in FY 1981  and fell to
$18 million in FY 1987 (see Table A-l).  Obligations were $26 million in FY 1990.
CoBank, the National Bank for Cooperatives

       CoBank, the National Bank for Cooperatives, was formed January 1, 1989, through the
consolidation of 11 of the nation's 13 Banks for Cooperatives.6 The federally chartered and
regulated bank is part of the 74 year-old Farm Credit System.  The Farm Credit System is a
government-sponsored enterprise (GSE), much like the Federal National Mortgage Association
(known as Fannie Mae). The special relationship of GSEs with the federal government allows the
acquisition of funds at very competitive rates, allowing GSEs to offer loans at highly competitive
interest rates. CoBank's funds come from the sale of Farm Credit System securities to investors
in the national and international money markets.

       CoBank is owned by approximately 2,400 U.S. agricultural cooperatives and rural utilities
that also are its customers.  CoBank's customer-owners capitalize the bank in providing equity
capital based on borrowings. Loans also are made on a non-member, non-patronage basis.  In
1990, CoBank held $12.9 billion in assets and had a loan portfolio of over $9 billion, of which
about $76 million represents loans to water systems. Because CoBank operates on a cooperative
basis, the bank's earnings are returned to its customer-owners in the form of patronage refunds.

        CoBank offers a variety of loan  programs and financial services  that are tailored to
agricultural cooperatives and rural utility systems.  CoBank makes intermediate and long-term
loans  for construction of new facilities,  remodeling or expansion of existing facilities, and land
or equipment purchases. These loans normally mature in up  to 10 years, but may be written for
up to 35 years. CoBank also makes seasonal loans to finance accounts receivables, inventories,
and other short-term needs. These short-term loans usually mature within 12 to 18 months. Fixed
and variable rates are available for both short-term and long-term financing.

       The 1990 Farm Bill  authorized CoBank to finance water and wastewater systems in
communities under 20,000 population.  Financing these water and wastewater systems is a natural
extension of CoBank's rural utility  business.   CoBank evaluates these  projects strictly  on
creditworthiness, as it does in all its loan programs.  CoBank does not offer loans at subsidized
interest rates, but as noted above, it does provide very  competitive interest rates.
                                                                            PageA-7

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                                      NOTES

1.     Office of Municipal Pollution Control, U.S. Environmental Protection Agency, State
       Revolving Fund (SRF) Final Report to Congress: Financial Status and Operations of Water
       Pollution Control Revolving Funds (May 1991 draft); and Office of Municipal Pollution
       Control, U.S.  Environmental Protection Agency < Initial Guidance far State Revolving
       Funds (January 1988).

2.     1990 Catalog of Federal Domestic Assistance (Washington, DC: U.S. Government Printing
       Office,  1990),  S2-S3; The Center for Community Change, Searching Jbr the Way that
       Works: An Analysis ofFmHA Rural Development Policy and Implementation (Washington,
       DC: The Aspen Institute, 1990); and U.S. General Accounting Office, Rural Development:
       Federal Programs That Focus on  Rural America and As  Economic Development,
       GAO/RCED-89-56BR (January 1989), 148-149.

3.     1990 Catalog of Federal Domestic Assistance, 129-130; and U.S. General Accounting
       Office, Rural Development, 166-167.

4.     1990 Catalog of Federal Domestic Assistance, 523-525, 529-530; and U.S. Department of
       Housing and Urban Development, 1989 Annual Report to Congress on Community
       Development Programs (April 1989), 25-42; and U.S. General Accounting Office, Rural
       Development, 185-186, 188-189.

5.     Personal communication with Dave Brower,  U.S. Army Corps of Engineers, April  11,
       1991.

6.     Personal communication with Dr. Richard Fenwick, Jr., "Vice President and Corporate
       Economist, CoBank, March 28, 1991; and "CoBank 1990 Annual Report"
                                                                          Page A-8

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                                    APPENDIX B
             CASE STUDY OF THE MAINE MUNICIPAL BOND BANK
BACKGROUND

       The Maine Municipal Bond Bank (MMBB) was created in 1972 to assist towns, cities,
counties, school districts, and other special districts with the financing of their respective public
improvements and other municipal purposes within the state. At this time, funds and accounts of
the MMBB are divided into three groups - the General  Tax-Exempt Fund Group (created in
1973), the Sewer and Water Fund Groups (created in 1990), and the Special Obligation Taxable
Fund Group (created in 1990).  The proceeds of bonds issued from the Sewer and Water Fund
Groups are used to make loans to local governmental units to finance wastewater collection or
treatment systems or water supply systems.
OPERATION

       The MMBB issues bonds and notes in its own name and uses the sale proceeds to purchase
the bonds and notes of local governmental units. Before the MMBB sells its bonds on the national
market, it approves local bond applications and includes them in the bond bank's portfolio for an
upcoming issue. At least twice a year, the MMBB will consolidate these local issues and market
a bond issue of $30 to 60 million or more.  The  MMBB usually wires bond proceeds to the
participating local governmental units two weeks after a bond sale. Around 95 percent of the local
governmental units that participate in the MMBB receive a  lower interest rate than if they
borrowed money independently.

       The MMBB pays  for all registration, trustee, and issuance fees for the participating
governmental units, with two exceptions. The local governments must obtain a preliminary legal
opinion from a recognized bond counsel prior to the final approval of their application and must
pay their share of the sales commission on the MMBB bonds.

       Operating funds for the  MMBB have been raised through arbitrage earnings from the
short-term investment of its bond proceeds prior to lending to the local governmental units and its
debt service reserve fund.  This  source of funding, however, was severely restricted by changes
in the 1986 Tax Reform Act that limit arbitrage earnings.  Existing funds are expected to  cover
MMBB operating costs until 1994 or 1995.  Subsequently, participating local governmental units
will have to pay some issuance costs or other fees.
                                                                            PageB-1

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SECURITY PROVISIONS

       The MMBB has a package of security provisions  that enables the bank to offer lower
interest rates to participating local governmental units.  These security provisions include:

       •      Required Debt Service Reserve - Money for this fund is included in the total
             amount of each and every MMBB issue, and by law must cover at least the highest
             amount of debt service payable in any future year.

       •      Supplemental Reserve Fund — MMBB has deposited over $3.5 million in this fund
             and may appropriate money from this reserve to make up for capital deficiencies
             elsewhere.

       •      "Moral Obligation of the State" - The state legislature has the option to vote on
             whether to replenish MMBB's Required Debt Service Reserve if it falls below its
             minimum level.

       •      "Intercept Mechanism" - If a local governmental unit defaults on its debt service
             payments  to  the  MMBB,  the state treasurer can withhold  funds otherwise
             earmarked for that governmental unit.

       •      "Umbrella Issues" - MMBB issues pooled bond issues mat represent a diversified
             portfolio of projects, thereby reducing the risk of the bond  issue and enabling the
             MMBB to achieve .a higher credit rating.
PROFILE OF MMBB ACTIVITY

MMBB Credit Rating: AA, AA    State Credit Rating:  AAA, AA+   (S&P, Moody's)

Debt Outstanding (from MMBB 1990 Financial Report):

       General Tax-Exempt Fund Group:        $1,042 million
       Sewer and Water Fund Groups:              24 million
       Special Obligation Taxable Fund Group:        4 million

Number of MMBB Issues (1973 -July  1990): 35

Types of Projects Funded (1980 - July  1990):

       32% for general municipal capital improvements
       11% for sewer and water projects
       57% for schools and municipal refinancing
                                                                            Page B-2

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PROFILE OF MMBB ACTIVITY (continued)

Types of Bonds Purchased:  80% general obligation bonds
                          20% revenue bonds

Credit Ratings of Participating Local Governmental Units: About 70% unrated

Number of Loans Outstanding: 752

Average Amount Borrowed:  $800,000 (a relatively small number of governmental unite have
                          borrowed over $5 million)

1990 Bond Issues:   MMBB raised over $118 million, which provided low-cost capital to 23
                   towns, 20 school districts, and 19 other local governmental units.
Sources:      Personal communication with Robert Lenna, Executive Director, Maine Municipal
             Bond Bank, April 12,  1991; the "Maine Municipal Bond Bank 1990 Financial
             Report;" bond prospectuses and other materials provided by the Maine Municipal
             Bond Bank; and Joni L. Leithe, "State Bond Banks," Credit Pooling to Finance
             Infrastructure: An Examination of State Bond Banks. State Revolving Funds, and
             Substate Credit Pools (Government Finance Officers Association, September 1988),
             37-38.   '
                                                                            PageB-3

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                                    APPENDIX C
                         SRF AFFORD ABILITY ANALYSIS
       Appendix C provides an initial analysis of the affordability of SRF loan financing. The
issues examined in this analysis are the effect of community size, SRF interest rate subsidies,
extending the SRF loan term, and providing supplemental state grants.
Effect of Community Size on Annual Household Costs

       Small communities have financial capability problems related simply to their size, because
they cannot take advantage of economies of scale available to larger communities.  The SRF
provides financing for only the capital portion of a community's wastewater facility costs. One
way to demonstrate the effect of community size on the ability to achieve economies  of scale is
to compare.the annual capital costs of SRF financing on a per-household basis  for different
community sizes.1  The average annual  capital cost per household represents a household's
proportional share of the annualized capital costs for a wastewater treatment facility.  Table C-l
presents average annual capital costs per household for an SRF loan at 4 percent interest, for four
community population sizes.  The size of the community  served by a facility has  a  substantial
impact on annual capital costs per household.  For a community of 1,000 population, the average
annual capital cost per household is 1.6 times greater than for a community of 10,000  population
and 3 times greater than for a community of 100,000 population.
         Table C-l. Comparison of Average Annual Capital Cost per Household by
                               Community Size (1989 $)
Community
Size
Average Annual Capital Cost
SRF Financing: 20-year loan
1,000 $146
2,500 122
10,000 89
100,000 47
per Household
at 4% interest




Effect of Interest Rate Subsidies on Annual Household Costs

      The impact of providing an additional interest rate subsidy (i.e., beyond that required to
offset the  added project costs from  federal requirements) to small communities can  be
demonstrated by comparing annual household costs for a wastewater treatment facility constructed
with an SRF loan assuming different interest rates.  For low-income small communities, low or
zero interest rates can increase the affordability of SRF financing because the interest rate charged
                                                                             Page C-l

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on SRF loans can have a significant impact on user charges,  as  represented by total annual
household costs.

       Table C-2 demonstrates the impact of lowering the SRF  interest rate (from 4 percent to
2 percent to zero percent) on annual capital costs and total annual costs per household, for smaller
communities of three different sizes (1,000, 2,500, and 10,000 population). In this analysis, the
total average annual cost per household represents a household's proportional share of bom the
annualized capital costs and the annual operation and maintenance (O&M) costs for a wastewater
treatment facility. As shown in Table C-2, lowering the SRF interest rate can significantly reduce
average annual capital costs per household, which reduces total annual household costs. However,
the reduction in total annual household costs is partially offset by the fairly high proportion of
annual costs (at least 60 percent) attributable to O&M.
   Table C-2. Annual Household Costs of SRF Financing (20-year loan) at Selected Interest
                           Rates, by Community Size (1989 $)
SI
Community Into
Size RJ
UP Average Annual
rest Capital Cost per
ite Household
1,000 4% $146
2% 121
0% 99
2,500 4% $122
2% 101
0% 83
10,000 4% $89
2% 74
0% 60
Average Annual
Cost per Household
(Capital + O&M)
$351
326
304
$306
285
267
$211
196
182
Effect of Interest Rate Subsidies on Aflbrdability

      While SRF interest rate subsidies can reduce annual household costs, examining the impact
on annual household costs alone does not indicate whether such subsidies actually increase the
affordability of wastewater treatment projects for small communities.  To measure the financial
impact on households,  annual  household costs  must be compared  to some  measure of a
                                                                              Page C-2

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Community's ability to pay for the wastewater treatment project.  EPA has used a variety of
affordability or  ability-to-pay  criteria to evaluate  whether a  community can pay  for  an
environmental facility.2

       One example of EPA's use  of ability-to-pay  criteria  is the  "Financial  Capability
Guidebook" developed in 1984 for the Construction Grants program. This guidebook includes a
variety of measures to assess both the financial condition of a community and the financial impact
on households  for a wastewater treatment project.  A number of financial ratios are  used to
evaluate the financial condition of a community. The financial impact on households is evaluated
by expressing total annual household costs (including capital and O&M) as a percentage of a
community's median household income.3  The guidebook  recommends using three threshold
values to assess ability-to-pay for a wastewater treatment project (see Exhibit C-l).  Where annual
household costs as a percentage of median household income exceed the threshold value, the
project is considered too costly relative to the community's ability to support the project.4
   Exhibit C-l. Affordability Criteria for Wastewater Treatment Projects from EPA's 1984
                            •Financial Capability Guidebook"
    Where a community's median
    household income (1980 $) is:

        < $10,000

       $10,000 - 17,000

        > $17,000
Total annual household costs as a
percentage of median household income
should not exceed:

                  1%

                1.5%

                1.75%
      While the above afibrdability criteria are tied to the Construction Grants program, the same
concept could be used to evaluate the affbrdability of SRF loan financing.  Exhibit C-2 presents
the afibrdability criteria with median household income updated to 1989 dollars.5
         Exhibit C-2. Affordability Criteria for the Analysis of SRF Loan Financing
    Where a community's median
    household income (1989 $) is:

        < $15,000

       $15,000 - 25,500

        > $25,500
Total annual household costs as a
percentage of median household income
should not exceed:

                   1%

                1.5%

                1.75%
                                                                             PageC-3

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       Because income levels vary among regions of the country, between urban and rural areas,
and between different communities of any given population size, affordability criteria based on
median household income are best used on a community-specific basis. Nevertheless, the criteria
in Exhibit C-2 may be  used  to  illustrate the affordability of SRF loan financing for small
communities as a whole. These affordability criteria, however, assess only the financial impact
on households.  Measures to evaluate the financial condition of a community are not  included in
this analysis.

       For purposes of analysis, two levels of income were chosen to represent two types of small
communities. The first income level is the U.S. median household income outside of metropolitan
areas, which was selected to represent a more typical small community.  The U.S. Bureau of the
Census reported a 1989 median household income of $22,400 outside of metropolitan areas (in
contrast, the average 1989 median household income for the United States is $28,900).6 For the
second income level, a median household income of $17,000 (approximately 75 percent of the
1989  median household income  outside  of metropolitan  areas) was  selected to represent a
low-income small community.

       In Table C-3, the total average annual household costs from Table C-2 are expressed as
a percentage of the two levels of median household income ($22,400 and $17,000) for the three
small community population sizes (1,000, 2,500, and 10,000). For a median household income
of $22,400, applying the threshold value of 1.5 percent from Exhibit C-2 shows that lowering the
SRF interest rate results in affordable financing in all but one case.  The exception is a 4 percent
SRF loan for a community of 1,000 population, which in this example represents the least interest
rate subsidy for the smallest community. For a median household income of $17,000, applying
tiie threshold value of 1.5 percent indicates that the smaller low-income communities  (1,000 and
2,500 population) would not find affordable financing using an SRF loan even at a zero percent
rate. However, the SRF interest rate subsidy provides affordable financing for a community of
10,000 population.  Depending on the population size and income level, some small communities
will benefit from an additional SRF interest rate subsidy.
                                                                            PageC-4

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    Table C-3. Affordability of SRF Financing (20-year loan) at Selected Interest Rates, by
                               Community Size (1989 $}
Community SI
Size Inte
Rs
IF Average Annual
rest Cost per
ite Household
(Capital + O&M)
1,000 4% $351
2% 326
0% 304
2,500 4% $306
2% 285
0% 267
10,000 4% $211
2% 196
0% 182
Annual Household
Cost as a
Percentage of
Median Household
Income: $22,400
1.6%
1.5%
1.4%
1.4%
1.3%
1.2%
0.9%
0.9%
0.8%
Annual Household
Cost as a
Percentage of
Median Household
Income: $17,000
2.1%
1.9%
1.8%
1.8%
1.7%
1.6%
1.2%
1.2%
1.1%
Effect of Extending the SRF Loan Term on Annual Household Costs and Affordability

      The effect of extending the SRF loan term to 30 years for a community of 2,500 population
is illustrated in Table C-4.  The 30-year loan term reduces annual capital costs per household by
21 to 34 percent from the  capital costs of a 20-year SRF loan (see Table C-2).  Applying the
affordability criteria (see Exhibit C-2), for a community with a median household income of
$17,000, the 30-year loan is not affordable at 4 percent interest.  However, the 30-year loan at
2 percent or zero percent interest would provide affordable financing for the low-income small
community.
                                                                              Page C-5

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 Table G4. Annual Household Costs and Affordability of SRF Financing with a 30-year Loan
          at Selected Interest Rates, for a Community of 2,500 Population (1989 $)
SRF
Interest
Rate
Capital
Financing Costs
Average Annual
Capital Cost per
Household
Total Financing Costs
Average Annual
Cost per
Household
(Capital + O&M)
Annual Household
Cost as a
Percentage of
Median Household
Income: $22,400
Annual Household
Cost asa
Percentage of
Median Household
Income: $17,000
4% $96 $280 1.2% 1.6%
2% 74 2S8 1.2% 1.5%
0% 55 239 1.1% 1.4%
Effect of Supplemental State Grants on Annual Household Costs

       The value of combining an SRF loan with a supplemental grant can be demonstrated by
showing  the effect on annual household costs.  Table C-5 shows the impact of combining  a
supplemental state grant (at 15 percent or 50 percent of eligible costs) with an SRF loan at
different  interest rates (4 percent,  2 percent,  or  zero percent)  for  a community of 2,500
population.  In this example, adding a supplemental state grant significantly reduces  average
annual capital costs per household.  Because O&M costs are not affected by the additional level
of subsidy provided by the grant, there is a less significant reduction in total annual household
costs.
                                                                               PageC-6

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 Table C-S. Annual Household Costs of SRF Financing (20-year loan) with Supplemental State
                  Grants, for a Community of 2,500 Population (1989 $)
            Level of Grant
              Assistance
 SRF
Interest
 Rate
         Average Annual
        Capital Costs per
           Household
             Average Annual
                 Costs per
                Household
             (Capital + O&M)
         No state grant
         15% state grant
         50% state grant
0%

4%
2%
4%
2%
0%
$122
 101
  83


$104
  86
  70


 $61
  51
  41
                                   $306
                                     285
                                     267


                                   $288
                                     270
                                     255


                                   $245
                                     235
                                     226
Effect of Supplemental State Grants on Affordability

      In Table C-6,  the  total  average  annual household costs for  a community of 2,500
population are expressed as a percentage of the two levels of median household income ($22,400
and $17,000). For a median household income of $17,000, applying the affordability criteria (see
Exhibit C-2) indicates  that the low-income small community would not be able to afford SRF
financing at even a zero percent rate without additional financial assistance. With a supplemental
15 percent grant, the low-income small community would not find affordable financing except at
a zero percent interest rate on the SRF loan.  The supplemental 50 percent grant, however,
provides affordable financing regardless of the various SRF interest rate subsidies used in this
example. Packaging a subsidized SRF loan with  a supplemental state grant can increase the
affordability of a wastewater treatment project for low-income small communities.
                                                                             PageC-7

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Table C-6. Affordability of SRF Financing (20-year Iran) with Supplemental State Grants, for
                       a Community of 2,500 Population (1989 $)
Level of SI
Grant Inte
Assistance Rz
UP Average Annual
rest Cost per
ite Household
(Capital + O&M)
No state grant 4% $306
2% 285
0% 267
15% state 4% $288
grant 2% 270
0% 255
50% state 4% $245
grant 2% 235
0% 226
Annual Household
Cost as a
Percentage of
Median Household
Income: $22,400
•1.4%
1.3%
1.2%
1.3%
1.2%
1.1%
1.1%
1.0%
1.0%
Annual Household
Cost as a
Percentage of
Median Household
Income: $17,000
1.8%
1.7%
1.6%
1.7%
1.6%
1.5%
1.4%
1.4%
1.3%
                                                                            Page C-8

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                                       NOTES

1.     See Office of Municipal Pollution Control, U.S. Environmental Protection Agency, State
       Revolving Fund (SRF) Final Report to Congress: Financial Status and Operations of Water
       Pollution Control Revolving Funds  (May 1991  draft),  8-1  - 8-2, F-l - F-6.  Annual
       household costs were calculated using the "User Charge Calculation Model" from this
       report.   Hie model  is based on theoretical typical wastewater treatment facilities and
       calculates the capital costs of facility construction as well as operation and maintenance
       costs.  Land costs that are ineligible under the SRF are not included. The model assumes
       that SRF financing covers 100 percent of total eligible costs  under the SRF.

2.     See "Summary of Affordability Criteria and Methods Used by EPA" (August 1, 1990
       draft) prepared by Brett Snyder for the EPA Affordability Workgroup.

3.     U.S. Environmental Protection Agency, "Financial Capability Guidebook" (1984), 41-45.

4.     Using such affbrdability criteria does not ensure  that all households in a community will
       have the ability to pay for a wastewater treatment project  Median household income
       represents  the midpoint of  community income  (i.e.,  one-half of the  community's
       households are below and one-half are above the median household income). For a given
       community, those households below the  median household income will bear the greatest
       financial impacts. Households living on fixed incomes or at the poverty level will be most
       adversely affected.

5.     The consumer price index was used to inflate EPA's 1980 median household income
       figures to 1989 dollars.

6.     U.S. Bureau of the Census, Money Income and Poverty Status in the United States, 1989,
       Current Population Reports:  Consumer Income, Series P-60, #168.
                                                                              PageC-9

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                                   APPENDIX D
                         SMALL COMMUNITY PROFILES
WASTEWATER PROJECT
Oak Ridge, Oregon - Population 3,400

The community's unemployment rate is 25 percent.  Oak Ridge's major industry is timber, but
the community sawmill has recently been shut down.
Project

Oak Ridge has an existing wastewater system that was built in the late 1960s.  The community is
currently planning to build a new facility in 1992. They are planning to construct a sequencing
batch reactor (SBR) with a filtration system.
Compliance Issues

The Oregon Department of Environmental Quality has issued compliance orders for the community
regarding its operation and discharge. The community is aware of the changes in regulations on
BOD and efficiency removal and is supportive of building a new facility.
Cost

The new wastewater treatment facility will cost the community $4 million.  The community will
use an EPA Construction Grant of $2 million and they are trying to obtain CDBG funds for
$500,000.  In addition, Oak Ridge will be using city revenue bonds totaling between $1.5 million
and $2 million, depending on the level of CDBG funding.
User Rates

The current user rate for wastewater is $7.50 for equivalent family unit (EFU).  If the community
is successful in receiving CDBG funding, the monthly user rate will be $16.50.  However, if the
community does not receive CDBG funds, the monthly user rate will be $18.50.
                                                                          PageD-1

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DRINKING WATER PROJECT
Joseph, Oregon - Population 1,150

The community is located in the upper northeastern comer of the state, just north of the Wallowa
Mountains.
Project

Joseph's drinking water comes from Wallowa Lake. The community is currently conducting a
feasibility study to determine if a slow sand filtration system is viable for the community.
Compliance Issues

Joseph needs to meet the filtration requirements under the Surface Water Treatment Rule. The
community is unable to demonstrate that they have sufficient control over the watershed since the
property surrounding the lake is privately owned.  As a result, Joseph is examining the option of
a slow sand filtration system to filter the surface water.
Cost

The facility will cost the community $2.5 million. The community has received combined grant
and loan funds from FmHA totaling $2,348,600. FmHA has granted the community $1,213,600
and has lent Joseph an additional $1,135,600 at 5 percent interest
User Rates

User rates recently doubled from $4 to $8 a month to pay for the repair and replacement of
deteriorating water lines.  Since the community received the FmHA funds, the monthly user rate
will be $18 a month. Without the FmHA financing, the user rates would have been $40 a month.
                                                                           PageD-2

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                                   APPENDIX E
                EFAB MEMBERS, WORKGROUP SUPPORT STAFF,
                 AND EXPERT EPA CONSULTANTS TO THE EFAB
 Environmental Financial Advisory Board
 (EFAB)

 EFAB Chair

 Richard Torkelson
 Deputy Commissioner for Administration
 New York State Department of
   Environmental Conservation
 Albany, NY

 EFAB Vice Chair

 Frieda K. Wallison
 Partner
 Jones, Day, Reavis & Pogue
 Washington, DC
EFAB Executive Director

Herbert Barrack
Assistant Regional Administrator
Region II, U.S. Environmental Protection
 Agency
New York, NY
 Small Conununitv Financing Strategies Workffroun
 Elizabeth Ytell (Workgroup Leader)
 Director, Water-Wastewater Division
 Rural Community Assistance Corporation
 Sacramento, CA

 Jack Bond
 City Administrator/Deputy Mayor
  for Operations
 Washington, DC

 Thomas  Christensen
 (Retired Supervisor)
 Charter Township of Ironwood
 Ironwood, MI

 Dr. Richard Fenwick, Jr.
 Vice President, Corporate Economist
vCoBank  National Bank for Cooperatives
 National Credit Services Division
 Denver,  CO
William B. James
Associate Director
Pmdential-Bache Capital Funding
Public Finance Department
New York, NY

John C. "Mac" McCarthy
State Director
U.S. Department of Agriculture
Farmers Home Administration
Alexandria, LA

Honorable Anne Meagher Northup
Kentucky State Legislator
Louisville, KY
                                                                          PageE-1

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Public Sector Financing OotJODC WorkPTQUD
George A. Raftelis (Workgroup Leader)
Partner
Ernst & Young
Charlotte, NC

William H. Chew
Senior Vice President
Municipal Finance Department
Standard & Poor* s Corporation
New York, NY

Roger D. Feldman, P.C.
Partner
McDermott, Will & Emery
Washington, DC

Shockley D. Gardner, Jr.
Executive Director
Virginia Resources Authority
Richmond,  VA
Robert F. Mabon, Jr.
Morgan Stanley and Company, Inc.
New York, NY

Marlin L. Mosby, Jr.
Managing Director
Public Financial Management, Inc.
Memphis, TN

Roberta H.  Savage
Executive Director
Association of State & Interstate Water
  Pollution Control Administrators
Washington, DC

Douglas P.  Wheeler
Secretary for Resources
Sacramento, CA
Economic Incentives Workgroup

Frieda K. Wallison (Workgroup Leader)
Partner
Jones, Day, Reavis & Pogue
Washington, DC

Honorable Beryl F. Anthony, Jr.
U.S. Representative
State of Arkansas

Dr. William Fox
Associate Director
Center foe Business & Economic Research
University of Te
Knoxville, TN
John Gunyou
Commissioner
Minnesota Department of Finance
St. Paul, MN

Heather L. Ruth
President
Public Securities Association
New York, NY

Richard Torkelson
Deputy Commissioner for Administration
New York State Department of
  Environmental Conservation
Albany, NY
                                                                           Page E-2

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Private Sector Incentives Workgroup

Warren W. Tyler (Workgroup Leader)
Vice President
State Savings Bank
Columbus, OH

J. James Ban-
Vice President and Treasurer
American Water Works Company, Inc.
Voorhees,  NJ

Philip Beachem
Executive Vice President
New Jersey Alliance for Action, Inc.
Edison, NJ

Joseph D. Blair
Executive Director
Massachusetts Industrial Finance Agency
Boston, MA

Honorable Pete V. Domenici
U.S. Senator
State of New Mexico

David W. Gilbert
Vice President
Envirotech Operating Services
Birmingham, AL
Harvey Goldman
Executive Vice President and
  Chief Financial Officer
Air and Water Technologies Corporation
Somerville, NJ

W. Jack Hargett
Vice President Government Relations
The Parsons Corporation
Washington, DC

Honorable William H. Hudnut, IU
Mayor of Indianapolis
Indianapolis, IN

Honorable Holland W. Lewis
Mayor of Mount Vernon
Mount Vernon, IL

Steven Lieberman
Assistant Director  for General Management
Office of Management and Budget
Washington, DC
                                                                            Page E-3

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Workgroup Support Staff
               Protection Aency
David P. Ryan
Comptroller

John J. Sandy
Director, Resource Management Division

David Osterman
Chief, Resource Planning and
  Analysis Branch

Helen Beggun
Chief, Grants Administration Branch
Region n

Alice Jenik
Chief, Policy and Program
  Integration Branch
Region n

Ben Abruzzo
Analyst

George Ames
Senior Analyst

Leonard Bechtel
Analyst

Apogee Research.  Inc.

Dr. Kenneth Rubin
President

Ann Carey
Vice President

Dr. Susan Jakubiak
Senior Economist

Matthew Hardison
Vice President
Margaret Binney
Analyst

Ellen Fancy
Analyst

VeraHannigan
Senior Analyst

Joanne Lynch
Analyst

Timothy McProuty
Senior Analyst

Eugene Pontillo
Senior Analyst

Kim Thomas
Secretary

Ann M. Watt
Analyst
Barbara Richard
Senior Financial Analyst

Lisa Akeson
Senior Economist

Amy Doll
Policy Analyst
                                                                             PageE-4

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 Expert Consultants to the EFAB (from EPA)
Stephen Allbee
Chief, Municipal Assistance Branch
Office of Wastewater, Enforcement,
 and Compliance

Marian Cody
Analyst
Grants Administration Branch
Office of Administration and
 Resources Management

Ann Cole
Small Community Coordinator
Office of Regional Operations and
 State/Local Relations

Michael Deane
Environmental Protection Specialist
Office of Wastewater, Enforcement,
 and Compliance

Ellen Haffe
Analyst
Grants Administration Branch
Office of Administration and
 Resources Management

James Home
Director, Water Policy Office
Office of Water
A. W. Marks
Senior Advisor
Enforcement and Program Implementation
 Division
Office of Ground Water and
 Drinking Water

Kitty Miller
Environmental Protection Specialist
Office of Water

Donald Rugh
Analyst
Office of Water

Peter Shanaghan
Mobilization Manager
Office of Ground Water and
 Drinking Water

Ronald Slotkin
Analyst
Office of Research and Development

Brett Snyder
Economist
Economic Analysis and Research Branch
Office of Policy, Planning, and Evaluation
                                                                         PageE-S

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                              ACKNOWLEDGEMENT
      The Board wishes to thank the many finance professionals and others who assisted in the
preparation of this statement. To a great extent, this statement reflects the diverse input of experts
in the field from academia, state and local government, the investment banking community, and
other professional organizations.

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