Go to... Home Federal Credit Concepts & Issues State Infrastucture Banks Quarterly Newsletter TE-045 Research Innovative Finance Program Guidance

5.0 Observations and Conclusions

During the 1990s, the Federal role in highway investment broadened to encompass alter-native approaches that complemented traditional grant funding. Through a combination of administrative and legislative changes, a new array of grant management tools such as partial conversion of advance construction, tapered match, and flexible match provided states greater ease in administering Federal obligation authority and offered them the opportunity to satisfy matching requirements under more flexible terms. Additional statutory changes allowed Federal-aid funds to be used to facilitate debt financing, thus accelerating project construction by many years and potentially expanding the overall level of investment in the nation's surface transportation infrastructure.

The case studies contained in Chapter 4.0 reviewed project sponsors' real world experi-ence with these innovative finance tools. Based on these case studies, Table 5.1 evaluates the capacity of each tool to achieve some of the benefits attributed to innovative finance. This table is intended only as a relative comparison of how likely a tool is to provide a particular benefit; each state's experience may differ based on individual legal environ-ment and project conditions.

5.1 Addressing Impediments

The capacity of innovative finance tools to produce the benefits shown in Table 5.1 lies principally in their ability to help states - or other project sponsors - surmount various financial hurdles that could otherwise lead to project delays or limit access to capital. Since 1994, sponsors have employed innovative finance strategies to help advance hundreds of highway projects. How were these advances achieved, and could these tools be further improved? To answer this question, it is helpful to examine how successfully the tools helped project sponsors overcome the impediments that these financial strategies were originally intended to address.

Under the TE-045 initiative, states proposed three separate tools intended to ease the strict project-by-project, payment-by-payment nature of the matching requirements that accompany almost all categories of Federal highway assistance. Flexible match and toll credits allow states to substitute other fund sources or credits from prior expenditures in lieu of state funding typically used to satisfy the non-Federal matching requirement; tapered match offers states new latitude to adjust the timing of such matching contribu-tions. These tools have proven very popular, helping states address near-term shortfalls in the availability of non-Federal matching funds and thereby accelerating the construc-tion of projects that otherwise might have to wait for a future state appropriations cycle.

Table 5.1: Benefit Potential of Federal Innovative Finance Tools

Another common target of those states proposing new grant management tools under TE-045 was the longstanding requirement for states to commit all necessary Federal obli-gation authority for a given project up-front. A need for more flexibility in managing the consumption of Federal obligation authority over the life of a project led to the development of two tools, one of which was later disallowed following a legal review. First, for projects constructed using advance construction, partial conversion of advance construction allows states to commit Federal obligation authority funds (i.e., "convert" the project to Federal-aid) in stages rather than all at one for the entire reimbursable amount. States also sought to address up-front consumption of obligation authority for projects that are not advance constructed through the development of a tool called phased funding. Seven states tested this tool on approximately 11 projects, but FHWA subsequently disallowed phased funding because it represented an up-front commitment to the Federal share of the project costs. Under advance construction, the Federal government makes no such commitment of funds until the time of a project's conversion to regular Federal-aid status.

GARVEE bonds, and supporting changes to advance construction that allow conversions to occur in multiple authorization periods, address one of the most significant barriers to debt finance generally: the need to identify a source of revenue to repay debt obligations. While GARVEEs do not generate new revenue, the new eligibility of bond-related costs for Federal-aid reimbursement provides states with one more option for repaying debt service. GARVEEs have been especially effective in accelerating large projects that would otherwise have completely dominated state construction programs or else have experienced substantial delays. GARVEEs' instrumental role in New Mexico's and Colorado's corridor programs provides an especially compelling case in point, with bond proceeds backed by future Federal-aid apportionments accelerating projects by as many as 25 years over pay-as-you-go options. Like all powerful tools, however, GARVEEs must be used judiciously. Although the issuance of GARVEE bonds produces a near-term infusion of new capital, the issuance also places a prospective claim on future Federal-aid apportionments. States must remain fully cognizant of the implications (both positive and negative) of incurring new debt obligations through the use of GARVEEs.

While the GARVEE mechanism provides the opportunity to retire debt using future Federal-aid apportionments, Federal credit initiatives lower barriers to revenue-backed debt financing by providing a new source of secondary and subordinate capital, poten-tially reducing senior investors' risk exposure. Both Section 129 loans and the loans, lines of credit, and loan guarantees offered under the TIFIA Federal credit program were designed to provide credit enhancement, absorbing just enough risk to allow projects on the cusp of financial feasibility to access the capital markets for the remainder of their bor-rowing needs.

Federal credit has enjoyed some success in this area; the subordinate capital provided through the Section 129 loan to the George Bush Turnpike improved debt service coverage on senior debt obligations and thus improved the affordability of these borrowings. For TIFIA-assisted projects like the improvements to Penn Station in New York and State Route 125 in San Diego, improved coverage ratios that will be created through the provision of subordinate TIFIA loans will similarly improve the risk profile and associated costliness of senior debt obligations.

Despite these successes, many observers believe that most projects obtaining credit assis-tance were already sufficiently creditworthy to have obtained financing even without this form of credit enhancement. As a result, credit support has likely not played a "make or break" role in the financing of these projects, but rather has managed to reduce financing costs by making the projects marginally less risky by virtue of Federal co-investment.

Finally, SIBs are geared to creating a new borrowing opportunity for projects that for rea-sons of scale or scope are not well suited to bond financing or to direct Federal credit. The volume of loans made as of the end of fiscal year 2001 approached $3 billion. Many of these loans have turned around quickly, however, suggesting that in some states, the program is functioning at least as much as a cash flow regulator as a debt financing strategy. Also, with about 70 percent of the loan activity concentrated in just four states, some of the less active states have held back on SIB implementation due to concerns about diverting Federal-aid apportionments from project grants to capitalization grants, and a lack of authority to use TEA-21 funds to capitalize. Still, those states that have committed to active SIB programs have valued the flexibility to use these funds for capitalization as well as for outright grants.

5.2 Transforming the Innovative into the Everyday

The range of tools that states and other project sponsors have tested since 1994 can signifi-cantly expand the nation's transportation financing capacity. Yet not all tools will be suited to every project, or can be applied in every state or local area. In addition, in order to apply these tools, states may need to develop administrative capabilities and policies to manage them. As formerly innovative practices become more fully integrated into the standard Federal-aid program, some of the major administrative and policy steps will include:

• Increasing Administrative Expertise - Implementation of many of the financing tech-niques discussed in this report requires education, training, and/or recruitment of experienced finance personnel. Innovative finance involves considering different types of risks and benefits that do not occur in the traditional grant program. For example, a state may need to evaluate the credit risks of a potential SIB borrower, or consider the costs and benefits of issuing GARVEE bonds versus up-front funding of projects.
  
  
• Expanding Monitoring Capability - Some tools, such as GARVEEs, Section 129 loans, and SIBs, will require states to make longer-term financial commitments, and will require long-term monitoring of project financial status and repayments. Governments that wish to apply these tools will need to commit resources to the monitoring activities and build the capacity to analyze the long-term implications of these commitments.
  
  
• Establishing Public/Private Policies - Some tools will require increased consideration of public-private policies that may be created or changed. For example, states may need to examine whether certain donations to projects will be allowed if they appear to advantage a donor, or if private operation and ownership of projects will be allowed. State and local governments that consider public-private arrangements may need to establish and/or revise policies regarding partnerships with the private sector.
  
  
• Integrating with Existing Planning Process - State and local governments will need to determine how to integrate innovative finance with their existing planning proc-esses. For examples, states that make loans as well as grants to projects will need to determine appropriate tradeoffs to make awards of grant funding and loans equitable across different geographic areas.

As innovative finance becomes increasingly more of a standard practice, decision-makers also will need to consider which tool(s) are best suited to the circumstances of the unique financing challenges they face. To help in this effort, Table 5.2 displays some criteria that may be used to match tools to projects. The criteria include major project characteristics such as size, revenue potential, and public or private sponsorship, and can help narrow down which tools might be appropriate for a given project.

Many different tools can apply to a single project, and in fact, the tools can and should be used in combination. For example, flexible match options such as toll credits may facili-tate the use of Section 129 loans; TIFIA assistance could be used on a project that also received a SIB loan; and advance construction is a necessary component of the GARVEE bond approach. The optimal combination of tools depends on the circumstances of each project and the particular situation in each state.

5.3 Opportunities for Continued Innovation

The financing strategies developed and tested throughout the 1990s have proven particu-larly successful in accelerating projects; tools that focus on debt financing have typically advanced projects' completion by 10 years or more. Although the dividends yielded by project acceleration are not always readily measurable, the economic benefits associated with better mobility, reduced congestion, faster and more reliable freight movement, and improved safety underscore the value of prompt project delivery. These benefits also indicate the very real costs imposed by project delays attributable to avoidable financial constraints.

Grant management tools have been particularly beneficial in overcoming state difficulties with non-Federal share requirements. However, despite their benefits, these tools remain ad hoc solutions to state difficulties with these matching requirements. The broad interest in funding strategies designed to make matching requirements less onerous suggests that there may be value in a comprehensive review of the role of the matching requirement and the advisability of retaining or altering existing provisions.

Some states have welcomed the flexibility under the SIB program to use part of their Federal-aid funding to capitalize state banks providing credit assistance. In the future, continuation of this program would allow continued experimentation, on a voluntary basis, that might permit additional benefits to be achieved by more projects in more states.

Table 5.2 Matching Tools to Projects

The Federal highway financing innovations of the 1990s, particularly in the form of Federal credit initiatives, also have shown promise in leveraging existing resources through three primary methods: attraction of capital investment from new financial part-ners, encouragement of new revenue sources, and generation of cost savings. Success in these areas has been less uniform than in the area of project acceleration, and the causal relationship between Federal policies and project sponsors' financial decisions has been more obscure.

Still, private investment in Federally assisted highway projects has increased under inno-vative finance initiatives; prior to the 1990s, such a blending of public and private capital in Federally supported highway projects was virtually unheard of. Several good exam-ples of this form of public-private partnership have emerged under the TIFIA Federal credit program and its predecessor projects, but co-investment of private capital in pub-licly sponsored projects continues to be thwarted by several factors, including uncertain returns on investment, private investors' reluctance to assume the political risks associ-ated with the earliest stages of project development, and the comparative expense of pri-vate versus public financing given the tax-exempt status of interest earned on publicly issued debt.

While public-private partnerships have typically been taken to indicate co-investment in projects' up-front capital costs, another promising form of partnership is innovative con-tracting, or reconfiguring the apportionment of responsibility for project development and operations between public and private sectors. This approach has been implemented with increasing regularity overseas, but long-term management contracts are rare in the U.S. While innovative contracting has been used in conjunction with projects that also use innovative finance tools, it has largely remained a separate phenomenon, untouched by Federal innovative finance initiatives. Future efforts may consider how to facilitate the use of innovative contracting in conjunction with these tools.

Increasing investment levels through the identification and collection of new revenues depends on choices of a decidedly local nature, and the Federal government has little direct influence over such determinations. Several of the innovations of the 1990s sought to reduce indirect institutional barriers to these decisions, however. For example, prior to the NHS Act, states would be expected to increase their share of funding on any Federally aided toll projects from 20 percent to 50 percent. By equalizing the non-Federal matching share required on both toll and non-toll road projects, Congress eliminated a disincentive that might have discouraged state or local governments from considering tolls as a potential revenue option. This change did not, however, require or even facilitate the actual levying of tolls or any other new revenue source.

Similarly, by creating new financial institutions that would offer new borrowing opportuni-ties for revenue-generating projects, and using Federal credit instruments to improve the creditworthiness and resulting market access of revenue-backed projects, Federal policy-makers reduced the barriers associated with the use of new revenue sources, while keeping the decision to seek new revenue sources firmly in the hands of state and local governments. Despite these efforts, expansion of the resource base through development of revenue-generating transportation infrastructure remains a challenge given public resistance to user facility charges. Continued experimentation with strategies to identify and reduce any Federal impediments to user charges could help increase overall investment levels, while keeping the decision-making power at the state and local level.

Finally, the opportunity to generate cost savings through the financial innovations devel-oped to date depends largely on the effectiveness of Federal loans and other credit prod-ucts in enhancing the creditworthiness of other borrowings. The Federal credit program has shown potential in this area, but the volume of projects that could benefit from credit assistance in this manner is uncertain. Savings also accrue when borrowing opportunities through SIBs or GARVEE issuances offer a cost-effective means to avoid inflation expense. However, it is unlikely that innovative financing tools alone offer the most effective mechanism for lowering project costs; improved technologies, maintenance practices, and streamlined approaches to project delivery offer at least as much promise in this area. As innovative finance continues to develop, these other cost-saving strategies will likely be used in combination on projects. For example, the first standalone GARVEE project, New Mexico State Route 44/U.S. Route 550, features both an innovative contracting tool (a long-term warranty) and a new innovative finance tool. Together, the tools accelerate the project and provide cost savings. While it would have been possible to complete the project with the use of either tool alone, the combination created a package which created significant benefits for both the contractor and the state DOT.

5.4 New Flexibilities; Minimal Federal Outlays

Since its inception, a hallmark characteristic of the innovative finance initiative has been the acceleration of projects and expansion of available resources without the commitment of new Federal funds. While annual funding for the Federal-aid highway program has grown as a result of legislative actions such as the creation of the guaranteed funding and revenue-aligned budget authority provisions in TEA-21, the financial innovations dis-cussed in this report have addressed the states' call for greater flexibility while consuming a minimal amount of Federal resources.

• The matching strategies - including flexible match, toll credits, and tapered match - merely alter the distribution of Federal funds among projects, resulting in no net increase in Federal outlays. Advance construction and partial conversion of advance construction similarly involve no additional Federal investment, but rather delay the point at which Federal outlays occur in a project's construction cycle.
  
  
• The SIB pilot program did result in a net increase to the size of the Federal-aid pro-gram, with Congress approving special appropriations of $150 million to fund capi-talization grants in fiscal year 1997. However, with the exception of that one-time provision of seed capital, the SIB program was created on the assumption that states are in the best position to determine whether to direct their regular Federal-aid funds to capitalization of a SIB.
  
  
• The payment of future debt service on GARVEE issues with future Federal-aid appor-tionments again causes no deviation from "base case" funding levels; GARVEEs sim-ply create a new eligible use for regular Federal grant funding.
  
  
• Though used in only a few instances, Section 129 loans also have been implemented at no additional cost to the Federal government. This is because Section 129 offers states the discretion to direct regularly apportioned Federal assistance to a new eligible use - provision of a loan - rather than a standard grant. One likely reason for the limited use of Section 129 loans in recent years is the availability of the TIFIA credit program, discussed below, which does not demand that states consume a share of their regu-larly apportioned funds in order to make project loans.
  
  
• The only element of the broad innovative finance initiative receiving substantial new resources is the TIFIA Federal credit program. TEA-21 authorized $530 million to cover subsidy costs for this program over the six-year period covered under TEA-21 - or three-tenths of one per-cent of the total six-year funding levels authorized for the entire Federal-aid highway program. (As of mid-2001, obligations of TIFIA funding had reached approximately $300 million out of the total $530 million available through 2003.) Despite the extra resources devoted to this lending program, internalization of repayment requirements through the TIFIA capital allocation model ensure that the amount of funding com-mitted under a TIFIA credit agreement is but a small fraction of the amount that might otherwise be directed to a given project in the form of a grant.

The enthusiastic response to the innovative finance test and evaluation research program established in 1994 demonstrated states' significant need for greater flexibility in the Federal-aid highway program; the subsequent implementation of the strategies identified during this effort has demonstrated the capacity to build greater flexibility into the program at minimal cost. The accomplishments in project acceleration and leverage of existing funding sources clearly show the sizeable returns generated through a near decade of Federal commitment to financial innovation, with a relatively small Federal outlay.

These returns represent the fruits of a decade of fresh thinking within Congress, U.S. DOT, and most important, the state, local, and private sponsors of the projects employing these financing tools. These partners played the pivotal role in generating most of the concepts profiled in this report and were also instrumental in converting the concepts into real-world test cases.

Now that these innovative finance tools have been created, the next frontier for innovative finance will be for States to determine how best to use them, in the context of their overall financing programs. For example, states will need to develop policies to determine what level of long-term borrowing is acceptable, and how projects will be selected. As innova-tive finance programs continue to evolve, FHWA anticipates that states, local govern-ments, and the private sector will continue to be the primary engine for creativity as the nation enters a second decade of commitment to innovative transportation finance.

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