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The term GARVEE (Grant Anticipation Revenue Vehicle) was created by FHWA innovative finance experts. It describes a type of debt vehicle made possible by changes in the Federal-aid Highway Program. Since it is not a legislative term, it cannot be found in Title 23 of the U.S. Code, Volume 23 of the Code of Federal Regulations, or in SAFETEA-LU.
The legislative change that facilitated GARVEEs occurred with the NHS Act of 1995, which was codified in Section 122 of Title 23 of the U.S. Code. Prior to this change, states could only use Federal-aid funds to pay debt service on a very limited basis. Section 122 allows states to claim reimbursement for principle, interest, and issuance costs on all eligible Federal-aid projects, rather than claiming construction reimbursement. Since this provision is now part of the regular Federal-aid Highway Program, there is no need to have specific GARVEE provisions in SAFETEA-LU's successor.
Yes. GARVEEs are not limited to any type of project or funds. Any program category under Title 23 is eligible.
Under Section 122 of Title 23, an eligible issuer is a state or political subdivision of a state or a public authority. State law may also specify authorized entities for GARVEE debt issuance.
No, there is no Federal guarantee for GARVEEs. GARVEEs can only be backed by a pledge of the state or local government, or other issuing entity.
No, neither legislation nor administrative policy sets limits on GARVEE amounts. However, GARVEE projects must be part of an approved, fiscally-constrained STIP, and GARVEE debt service must appear on that STIP.
There is no official guidance or recommendation on this issue. Many states have tended to limit the percentage in some fashion, ranging from 10 to 50 percent.
No, no legislation, regulations, or administrative policy limits GARVEE terms. The market determines what term is an acceptable risk, and over how many anticipated highway funding reauthorizations a debt instrument should span.
There is no recommended or suggested term. Most states have issued debt between 10 and 15 years. Since highway reauthorization bills typically have covered four to six years' worth of funding, most GARVEEs to date will probably span two to three highway authorization periods.
No, all interest and issuance costs are eligible. State and local governments will use their own procedures to ensure that interest rates and issuance costs are reasonable, based on current market conditions.
Any Federal-aid highway funds that could be used to pay for transit projects through the provision for flex "funds" or other funding flexibilities could also be used to repay debt instruments used to finance transit projects. Since flex "funds" are transferred to the Federal Transit Administration (FTA), their use for debt service is subject to Title 49 requirements and FTA guidelines. Not all Federal-aid highway funding categories can be used for transit, which could affect debt capacity levels and coverage ratios.
The maximum Federal share of the cost of a bond issue project approved under Section 122 is the share as defined under Section 120 of Title 23. This constitutes the legal pro rata share in effect at the time of execution of the project agreement. For any bond issue, the Federal share eligible for reimbursement depends on the amount of bond proceeds applied to approved Federal-aid projects, including payment of soft costs, such as capitalized interest, issuance expenses, and credit enhancement fees. In situations where 100 percent of project costs are debt financed through one bond issue, the bond-related reimbursements may be measured on a nominal, current-year basis (e.g., 80 percent of each debt service payment will be payable from Federal-aid and 20 percent from state match.) This will simplify both State Transportation Improvement Program (STIP) planning and the calculation of reimbursement amounts and shares. However, this may not always be the case. The Federal and non-Federal share may be financed separately. For example, the Federal share may be debt financed, while the state share is funded on a pay-as-you-go basis.
No. Tapered match (allowing the Federal share to vary over the life of the project, as long as it is ultimately the appropriate ratio) is not permitted on debt-related reimbursements.
Yes, non-cash matches can be used as the non-Federal share of a GARVEE-financed project.
Yes, toll credits authorized by Section 129 of Title 23 can be used as the non-Federal share of a GARVEE-financed project.
Yes, interest earned on bond proceeds is considered eligible as a non-Federal match.
For a GARVEE- or GAN-funded project, the Federal share of the debt-related costs (e.g., interest and principal payments, associated issuance costs, and ongoing debt servicing expenses) anticipated to be reimbursed with Federal-aid funds over the life of the bonds should be designated as AC in the transportation plan/program document showing GARVEE/GAN bond proceeds as the revenue source. In the case of projects taking advantage of the new Debt Service Reserve reimbursement capability, the same process should be followed, but including immediate repayment of the debt service reserve in the first year of the debt.
The full cost of planned GARVEE projects (including interest costs) should appear on the Long-Range Plan.
Issuance costs include the following: underwriters discount; rating agency fees, printing, publication, or advertising expenses with respect to the bonds; all fees, expenses, and costs of registrars and paying agents; and all fees, expenses, and costs of attorneys, financial advisors, bond counsel, accountants, feasibility consultants, computer programmers, or other experts employed to aid in the sale and issuance of bonds. Credit enhancement fees include bond insurance, premiums, and letter or line of credit fees.
A reserve account or contingency fund required by (or incidental to) the debt issuance and capitalized by bond proceeds is considered an eligible Federal-aid expense. The funds deposited in such an account, along with any interest earnings, must be used for project costs - either on a current basis (including interest) or as a final payment to the bondholders. They cannot be released and disbursed to any other party for any other purpose. If the reserve account is to be liquidated to make the final debt service payment, it will not be eligible for Federal-aid reimbursement. Likewise, if unused bond proceeds are applied to pay principal and/or interest, such payments will not be eligible for reimbursement.
Yes, a SIB would be an eligible debt-financing instrument, and debt service costs would be eligible for reimbursement.
Initial GARVEE guidance required states to choose between being reimbursed for debt service costs on a project and being reimbursed for construction costs. That provision was intended to prevent states from seeking reimbursement for both construction and for the debt service for bond proceeds that financed the construction.
Revised guidance issued by FHWA in March 2004 clarifies that both types of financing can be used on the same project, as long as only one type of reimbursement is used for each expenditure. At the time the project agreement is signed, the state will make an election to seek reimbursement for debt service and/or related issuance costs in lieu of reimbursement for construction costs. FHWA prefers that each project be reimbursed either on the basis of debt-related costs or on invoice costs (not both). However, FHWA will consider exceptions to this either/or provision, if the state provides assurance that the project costs being reimbursed from the bond proceeds can be identified and tracked. For example, the bond proceeds may used to fund a project phase or a specific activity, or be limited to a dollar amount per project.
In the case of government-issued debt, arbitrage occurs when a government entity issues bonds obligating it to pay one rate of interest, and is able to invest the bond proceeds at a higher rate of interest. For example, a bond might be issued at 4.5 percent interest, but a government entity might be able to earn 5 percent interest on the bond proceeds. The resulting gain is referred to as arbitrage earnings. The arbitrage earnings on tax-exempt bonds are constrained by Federal tax laws. Arbitrage earnings that exceed limits imposed by Federal regulations must be rebated to the Federal government. Generally, a government issuer can avoid rebating interest earnings on construction bonds if it expends 10 percent of the proceeds and earnings within six months, 45 percent within one year, 75 percent within 18 months, and 100 percent within two years. The IRS exception provisions also permit an issuer to pay a penalty rather than a rebate if these schedules are not satisfied.
Any arbitrage penalty incurred by a GARVEE issue is not eligible for Federal-aid reimbursement in accordance with Federal policy, and must be covered from other sources. This exclusion from allowable costs is addressed in the March 2004 GARVEE Guidance. Specifically, 2 CFR Appendix B to Part 225 (Selected Items of Cost) (formerly OMB Circular A-87), Section 16 states that Fines, penalties, damages, and other settlements resulting from violations (or alleged violations) of, or failure of the governmental unit to comply with, Federal, state, local, or Indian tribal laws and regulations are unallowable except when incurred as a result of compliance with specific provisions of the Federal award or written instructions by the awarding agency authorizing in advance such payments."
The premium is the amount by which an issue's proceeds differ from the face value of the bonds. If there is a premium on the transaction, it means that bondholders bought the bonds for higher than their par amount "or face value" (e.g., they bought a $1,000 bond offering 5.5 percent interest, for $1,050). Investors might do this because the interest rate of 5.5 percent is higher than prevailing interest rates. In the bond pricing, underwriters and financial advisers might set the rates at slightly higher than prevailing market rates to ensure that the proceeds are sufficient to construct the project, so they might offer slightly higher than prevailing market rates. Different combinations of face value and interest payment may appeal differently to different investors.
FHWA and the state must be certain that proceeds generated from the sale of bonds go towards the project for which the bonds were sold. Those net proceeds would include the premium. There may be an issue with the premium if the net proceeds are more than needed to construct the eligible project. In this case, the excess might be used to cover debt service, which would reduce the Federal funds required to pay debt service.
In this case, the state does not need to give FHWA credit. Interest earned on bond proceeds is considered state funds. If a state chooses to use those funds for construction expenditures and/or payment of debt service, it can count as part of the non-Federal share required to match the Federal share of debt service.
The state does have to wait until all bonds are paid before it can close out a project. The state may wish to discuss a closing process with the Division, for example in the case where all the usual project construction closing requirements (e.g. final inspection, etc.) are satisfied, but the financial closing will still have to wait until the debt service is fully repaid.
No, a GARVEE project has to be defined like all other projects. The project must be eligible for Federal-aid funds. The bond issuance itself is not eligible for funding and accordingly the debt cannot have a project number associated with it. With a GARVEE-financed project, the only difference is that debt service, including interest and issuance costs, must be paid in addition to construction costs, which are covered by the principal.
SIBs and GARVEEs can work together in several ways to secure financing for eligible Federal-aid projects.
SIB as GARVEE Lender
Since SIB loans may be repaid with Federal-aid funds, the SIB can be the source of financing for a loan repaid with Federal-aid funds. In this case, the SIB could be reimbursed under Section 122 of Title 23 for a loan made to an eligible project. In essence, the SIB would play the same role as a commercial bank or the capital markets, providing the capital that will eventually be repaid with Federal-aid funds. Oregon's SIB uses this model extensively.
SIB as Credit Assistance to GARVEEs
If a state DOT or local government instead seeks to finance a project with a GARVEE bond obtained from the capital markets, a SIB can provide a line of credit, interest rate buy-down, or other form of credit assistance to the GARVEE debt. This SIB credit assistance would effectively lower the interest rate on a GARVEE instrument. This technique could be particularly useful for local governments or tribal governments that are issuing GARVEEs, since they generally have lower coverage ratios than bonds issued by state DOTs. For example, suppose a local government received $1 million in Federal-aid funds annually, and wanted to start a project that cost $6.5 million. If the government issued a GARVEE bond at 6 percent, the annual debt service would be approximately $883,000, with a debt service coverage ratio of 1.13. With SIB credit assistance, the local government could probably obtain a higher rating, and either borrow more funds or achieve a lower interest rate.
SIB as Subordinate Lender
Finally, a SIB loan that finances the same project as a GARVEE can be structured as a subordinate loan that will also assist the credit rating of the GARVEE. The GARVEE bondholders may be willing to accept lower interest rates on such a transaction, because they would be repaid before the SIB in the event of a shortfall. For example, if the local government mentioned above were able to finance a percentage of the project with a SIB loan, it would be able to increase its coverage ratio, and lower its interest rate. If the source of repayment on the SIB loan is non-Federal, it could even serve as all or part of the non-Federal share required to match the GARVEE debt service payment.
Yes, debt instruments issued by 63-20 corporations may be repaid with Federal-aid funds, as long as the bonds are issued on behalf of the state and the proceeds are used for Title 23 eligible projects.
There is no Federal prohibition or restriction that would prevent a local government issuing a GARVEE, but local governments may face more legal and financial issues than state governments.
Legal Issues - First, the local government would need to have the authority under the laws of its state to issue debt or otherwise borrow funds. In many states, obtaining such borrowing authority requires a vote of the local governing body, state legislature, and/or approval by voter referendum in the affected area. Second, a local government would have to assure the capital markets that it has the legal authority to determine use of the Federal-aid funds that are being pledged. Such assurance might take the form of a Memorandum of Understanding (MOU) between the local government and the applicable state DOT. Even if the local government obtained such an MOU, the capital markets would probably take into consideration the history of the relationship between the state DOT and the local government, the process for allocating Federal-aid funds within that state, and the enforceability of any financial commitments under state law.
Financial Issues - Local governments might have more difficulty issuing GARVEEs backed solely by Federal-aid funds (a standalone "GARVEE") because a coverage ratio on a local GARVEE is likely to be much lower than for state debt issuance. For example, if a local government received (on average) $10 million in Federal funding each year, and proposed to issue a bond with debt service of $7.5 million per year, its coverage ratio would be only 1.33. In most cases, state-based GARVEEs can easily achieve higher coverage ratios, because of the high relative size of state Federal-aid programs to the amount of debt service. With lower coverage ratios, local governments may need backstop pledges, bond insurance, or credit assistance from the Federal or state government to achieve acceptable bond ratings and low interest rates. Programs such as state bond banks or state infrastructure banks could provide credit assistance to local government issuers.
Instead of having local governments issue their own GARVEE debt, some state governments are partnering with local governments in innovative ways. In California, the state GARVEE program issues bonds on behalf of local governments, which can seek capital funding for projects if they pledge future allocations of funding toward repayment. This provides local governments with the benefit of state bonding authority (and its bond rating). In Mississippi, the state bond bank has assisted local projects by issuing debt repaid by future Federal bridge funding.
Under Section 122 of Title 23, Federal-aid funds, including tribal allocations from the Indian Reservation Roads (IRR) program, may be used to pay the interest and issuance costs of bonds issued to advance eligible IRR projects. While tribal governments may use Federal-aid funds to repay debt service, the Federal government does not guarantee the tribally issued bonds. The Bureau of Indian Affairs (BIA) uses the term "flexible financing" rather than "innovative financing" to describe bonding and other financing arrangements.
Example 1 - A tribal government receives an annual IRR allocation of $150,000. The tribal government could pledge this amount towards a project costing $1 million, and issue a bond with a 10-year term, assuming a six percent interest rate. The tribal government could use the bond proceeds to begin the $1 million project immediately, and pay the debt service (approximately $136,000 annually) on the bond with its future IRR allocations. The remaining amount of the annual IRR allocation could be used for other projects.
Tribal governments also may be eligible to apply to states for financial assistance through a State Infrastructure Bank (SIB) program to advance eligible IRR projects. As has been discussed in IFQ previously, a number of states have active SIB programs, ranging in size from under $100,000 to $80 million or more. These banks can provide loans, lines of credit, and loan guarantees for eligible transportation projects. The maximum term for loans is 35 years, but initial repayments do not have to begin until five years after project construction. Interest rates and exact loan terms are set by the state DOT involved, and/or by the SIB itself, if it has a separate governing body. Federal-aid funds, including IRR funds, may be used to repay these loans.
Example 2 - A tribal government's IRR allocation is $100,000, and it plans to begin a project that will cost $300,000. The tribal government could apply to the state DOT's SIB to provide them a five-year loan for the project. The tribal government would pledge to use approximately $71,000 of its IRR allocation each year to repay the loan at six percent interest. The remainder of the annual IRR allocation, or $29,000, would be available for other projects.
Example 3 - A tribal government receives an annual IRR allocation of $150,000. The tribal government could pledge this amount towards a project costing $1 million, and issue a bond with a 10-year term. The tribal government could use the bond proceeds to begin the $1 million project immediately, and pay the debt service of the bond with its future IRR allocations. If the capital markets demand a higher interest rate than six percent, the tribal government could apply to the state to use a SIB line of credit to provide additional guarantee of repayment of the bond. The tribal government could then negotiate a lower interest rate, because the SIB line of credit would be available in the event of a temporary shortfall.
A GARVEE is any bond, debt, note, or other instrument for which a state claims reimbursement for debt service under Section 122 of Title 23. The proceeds of GARVEE bonds must be used for projects that are eligible for Federal aid and that follow Federal requirements. As debt service becomes due, states bill the Federal government for the applicable Federal share of debt service (typically 80 percent) and receive reimbursement. For example, if a state issued a $100 million bond whose debt service was $12 million annually for 10 years, the state would claim reimbursement for 80 percent of $12 million, or $9.6 million, until the debt is retired. The reimbursement includes any interest and issuance costs associated with the bond.
An Indirect GARVEE is a bond whose debt service is paid from construction reimbursements from eligible Federal-aid projects, as well as other sources. While the state may pledge its Federal construction reimbursements for debt service, the reimbursements it receives are not linked in any way to the Indirect GARVEE; instead, they are made based on eligible construction expenditures on any federally eligible projects.
The construction reimbursements that a state uses to pay Indirect GARVEE debt service may be from projects that the bond proceeds paid for or from entirely separate projects. Because the construction reimbursements are not associated with a debt issuance, the state is not eligible to claim reimbursement for interest and issuance costs on Indirect GARVEEs. Indirect GARVEEs are issued under state laws and requirements, and proceeds from them do not necessarily have to be used on Federal-aid projects. However, any project that ultimately receives Federal-aid construction reimbursement must follow all Federal-aid requirements.
Depending on state laws, a state might be able to issue either type of vehicle. Some states might prefer to issue a GARVEE in order to claim interest and issuance costs and in order to preserve a direct link between the project and the funds used to repay its debt service. Other states may forgo the additional eligibility for interest and issuance, and issue an Indirect GARVEE because it might allow them to use construction reimbursements from a variety of projects for debt service. Some states may find it difficult to issue Indirect GARVEEs because construction reimbursements become subject to appropriation by the state legislature when received, or are otherwise restricted by state law.
In both cases, a state does not receive any additional Federal-aid through using either vehicle; it simply elects to use its Federal aid funds in different but equally legitimate ways.
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