WIFIA: Examination of synergies with the Muni bond market
Economic gains are possible when investors with different strengths and preferences are combined in a single financing. This happens at the WIFIA loan program.
By John Ryan
The WIFIA Loan Program provides long-term loans for qualifying projects at the US Treasury interest rate. Since debt capital markets start with this rate as a minimum benchmark and add a spread for credit risk, liquidity premiums, and stock returns, in theory a WIFIA loan should always be a cheaper alternative. than the equivalent of the market, is not it?
In practice, things are not that simple.
The vast majority of WIFIA borrowers are highly rated public water agencies that can access the tax-exempt municipal bond market. As in any other part of the debt capital markets, municipal rates start with the Treasury curve and add all the spread components that cold-eyed bond buyers need. But unlike other market segments, well-equipped investors can also to subtract something – the value of the tax-exempt status of the overall return. In a competitive market, the value subtracted from the tax exemption can exceed the positive spread, resulting in rates below the Treasury curve. It depends on many variable factors, but this is usually the case for borrowers with good ratings and with maturities of around 20 years.
Indeed, the highly rated clientele of WIFIA public agencies can often choose between two good alternatives supported by the federal government. It may sound like a simple binary choice, at least when it comes to minimizing the cost of debt service. When expected munite rates are low relative to the Treasury curve, stick to a 100% bond issue. When they do not replace – as is currently the case – obligations for the maximum amount of a WIFIA loan, 49% of the capitalized cost of the project. Isn’t it still simple?
Except that an even better result is possible.
The choice does not have to be binary. Instead of just a prorated substitution based on the lowest rates, municipal bonds and a WIFIA loan can be synergistically combined to further reduce costs and expand structural options.
As with many capital structures, the synergies in this case arise from very different preferences and strengths between the two sources of debt, and how these are reflected along their full yield curves.
The municipal bond market is dominated by high income US individual investors (direct or through bond funds) because they have a unique ability to monetize the tax exemption. Muni’s market clearing prices will reflect this, but also their preferences as individual investors. Their investment horizon centers on natural lifespans, they will want cash for unforeseen events, and many face future uncertainties in income or tax rates. It’s an image on a human scale, and the municipal yield curve reflects it: very competitive on the shortest maturities (often significantly lower than Treasury rates) but rising relatively sharply towards the long term and increasingly unpredictable. beyond the maturities listed on the 30-year market.
In contrast, the US Treasury market is dominated by institutional investors from around the world, and a federal infrastructure loan program like WIFIA may be the ultimate institutional lender. Investment horizons are very long, goals imply large-scale results, and illiquidity is not an issue. The Treasury curve is generally less steep than its mun equivalent. More importantly, rates beyond 30 years are assumed to remain “flat forward” indefinitely – and this assumption is made effective in WIFIA’s rate setting.
To finance a large-scale, long-term infrastructure project over 40 or 50 years, these two very different investors go hand in hand. The WIFIA program allows for non-proportional personalized amortization (which they call “sculpting”) so that each investor can take advantage of their strengths. The tranche with 51 percent can be paid off first, all in the predictable 30-year market. In this way, the Series Bonds will reflect the most competitive monetization of tax-exempt value as well as the overall duration and liquidity preferences of individual investors – they really like infrastructure, but not too long.
The 49% tranche of the WIFIA loan can begin to be repaid after the repayment of the bonded bonds, ideally around year 30. The interest rate of the WIFIA loan will be primarily determined in the flat part of the Treasury curve, which is the lowest possible rate for such long term debt. Since things can change a lot during such a period, it should be noted that WIFIA loans are prepayable at par at any time.
The combination of municipal bonds and a WIFIA loan in this example can improve the cost savings on debt service for long-term project finance by 30-40%, compared to prorated amortization. . A large number, but an intuitive result based on the very different profiles of the two lenders. There are likely many additional synergies between the two, including those that are less quantifiable or specific to a situation.
Considering the scale of long-term infrastructure projects that will need financing in the decades to come, synergies between the municipal bond market and the WIFIA loan program should be actively developed by potential borrowers – and by the lenders themselves. Why not? It’s a win-win classic, straight out of the Econ 101.
John Ryan is director of InRecap LLC. InRecap focuses on alternatives to debt for the recapitalization of basic public infrastructure. Ryan has extensive experience in structured and project finance. He was recently an expert consultant to the US Environmental Protection Agency. The opinions expressed in this article are solely those of the author.