The strategic goal of a federal transportation credit program should be to leverage limited federal funding in a prudent, budget-effective way in order to help advance major projects of national significance.
Under the current federal-aid grant reimbursement program, the federal contribution generally may not exceed 80 percent of project costs. If one assumes that the remaining 20 percent of project costs covered by state, local, and private contributions is really induced by the federal contribution (as opposed to simply substitute for the federal contribution), then the maximum potential leveraging ratio in terms of total investment to federal contribution is 1.25 to 1.
By offering a mixture of different types of credit designed to strengthen the creditworthiness of the balance of a project's debt, the federal government could induce substantial additional infrastructure investment from private capital sources. As a "patient investor" willing to take a long-term perspective for projects with substantial public benefits, the federal government can play a crucial role by lending key portions of project capital on flexible terms. The federal government could accomplish this by becoming a minority investor whose loans would either represent a supplemental source of capital or have a secondary claim on project revenues. Project sponsors would repay the principal and interest on federal loans from project revenues after meeting their annual payment obligations on senior debt. If no interest rate subsidy were involved, the federal government would have no long-term costs other than the risk of default.
Over the long term, it has been demonstrated that a junior-lien infrastructure loan has the same effective long-term risk profile as senior indebtedness. 1 Although there frequently is a "ramp-up" period of revenue uncertainty, start-up toll roads and other infrastructure projects almost invariably do generate sufficient revenues in the long run to effectually repay both senior and junior indebtedness. If projects with acceptably low risk were provided credit assistance, the expected loss to the federal government from default would be relatively low, and so would the corresponding budgetary costs. A low budgetary cost of credit implies a large leverage ratio, since the leverage ratio of federal funds is equal to total project costs divided by the budgetary costs of providing federal assistance. 2
This chapter outlines the key design principles of a credit program and describes four specific credit products that could be offered by the federal government to sponsors of transportation projects: direct, flexible payment loans; loan guarantees; standby lines of credit; and development cost insurance.
If a federal credit program for surface transportation is undertaken, it should be designed based upon the following six key principles:
Infrastructure projects have different financing requirements at different stages of their development and operation. The credit products should address the specific financing needs of projects during these different stages. There are four distinct stages in the typical life cycle of a major transport facility. These stages are defined as follows:
As shown in Figure 2.1, a federal credit program could offer several different types of financial assistance (i.e., product lines), designed to address a project's varying requirements throughout its life cycle.
Direct, flexible payment loans from the federal government would provide sponsors with permanent financing of construction costs in a manner that enables loan repayments to coincide with the receipt of revenues, rather than according to inflexible repayment schedules.
Loan guarantees by the federal government would be designed to attract private capital on similar terms to direct, flexible payment loans, but the loans would be funded from private capital sources.
Standby lines of credit represent secondary sources of funding in the form of contingent federal loans that may be drawn on to supplement project revenues if needed during the ramp-up period.
Figure 2.1 Potential Forms of Federal Credit Assistance over a Project's Life Cycle
Development cost insurance would provide federal reimbursement to a project sponsor for a portion of the pre-construction costs incurred in the development phase in the event the project fails to proceed to construction. 4
Figure 2.2 illustrates the flow of funds between DOT, private lenders, and project sponsors for each of the potential credit products described above.
In absolute terms, the funding needs are greatest for direct loans, loan guarantees, and standby lines of credit, and the major thrust of a federal credit program should be oriented to these products. Due to the uncertainty associated with projects during the development stage, development cost insurance is best offered through an experimental pilot program of limited scope, perhaps not more than ten percent of the program's budget authority.
It is contemplated that a project would be eligible for only one of the three major credit products (direct loan, loan guarantee, or standby line of credit) to avoid risk redundancy. However, it should be permissible for a project which benefits from development cost insurance in its initial phase to seek federal credit assistance for permanent financing if it proceeds to construction and therefore does not require any insurance payments.
The program would draw on the unique ability of the federal government to be a patient investor, with longer-term time horizons, lower liquidity requirements, and greater flexibility than private investors. Even in the role of a minority investor, the federal government's involvement could help instill investor confidence while addressing market gaps, thereby inducing substantial levels of private co-investment.
Table 2.1 summarizes specific features of the credit products, including maximum term and amount, repayment provisions, and interest rates. The remainder of this chapter describes the individual credit products in detail.
| Credit Product | Description | Project Phase | Maximum Term | Maximum Amount | Repayment Provisions | Interest Rate |
|---|---|---|---|---|---|---|
| Direct Loan | Direct, flexible payment loans from the federal government would provide financing of construction costs in a manner that enables loan repayments to coincide with the receipt of revenues rather than adhere to inflexible repayment schedules. | Construction through Maturation | Up to 35 years after construction is complete. | Up to 33 percent of project costs. | Could have a junior claim on annual revenues. Deferral of principal and interest is permissible during the ramp-up phase (though interest will continue to accrue). | Set at the pre-vailing yield on U.S. Treasury bonds issued for a comparable term. |
| Loan Guarantee | Loan guarantees from the federal government to private lenders would attract private capital on similar terms as direct loans. | Construction through Maturation | Guarantees would apply for the term of the private loan (up to 35 years). | Up to 33 percent of project costs. | Could have a junior claim on annual revenues. Deferral of principal and interest would be negotiated between borrower and lender. | The interest rate on the private loan would be negotiated between project sponsor and lender, with DOT approval. |
| Standby Line of Credit | Standby lines of credit represent secondary sources of funding in the form of contingent federal loans that may be drawn on to supplement project revenues if needed during the ramp-up phase. | Ramp-Up | Draw could be made up to ten years after construction; repayments must be completed within 35 years after construction. | Up to 33 percent of project costs with up to 20 percent of the line available in any given year. | Repayment of draws would have terms similar to direct federal loan. | The rate on contingent federal loans would be set at the prevailing yield on 30-year U.S. Treasury bonds. |
| Development Cost Insurance | Development cost insurance would provide federal reimbursement to project sponsors for a portion of the pre-construction development phase costs in the event the project fails to proceed to construction. | Development | Coverage could be claimed at the end of five years if the project failed to proceed to construction. | The lesser of 40 percent of pre-construction costs or $4 million. | If, after claiming insurance coverage, a project advances to construction, then the federal payment is reimbursable. | Not applicable. |
Flexible payment loans would be direct loans from the federal government to project sponsors to provide long-term, fixed-rate financing of a portion of construction costs.
Such a loan might be for an amount up to 33 percent of the cost of a project and could have a final maturity date as long as 35 years after completion of construction.
The interest rate would be established at the time the loan agreement was executed, and would be set at the prevailing yield on U.S. Treasury bonds issued for a comparable term, thus precluding any significant interest subsidy cost.
The terms and conditions of each loan would be negotiated between the federal government and the borrower but would enable the government to accept a claim on project revenues junior to the project's other senior indebtedness. In essence, the federal loan could be viewed as being payable from the excess coverage on the project's senior debt.
In its role as a patient minority investor, the federal government could also provide flexible repayment terms on its junior-lien loan. If, at any time during the project's first ten years of operation, annual project revenues, after paying operation and maintenance costs and senior debt service requirements, were insufficient to meet current debt service on the loan, the federal government could defer interest and principal payments. Any deferred payment could be added to the outstanding loan balance and would continue to accrue interest. The loan agreement would require the borrower to take certain actions to modify its rates and charges or reduce operating expenses to catch-up to the original loan repayment schedule. In the event of default the flexible payment loan could have a parity or co-equal claim on project assets with other investors.
The loan could be prepaid at any time from excess revenues. As operations stabilize after ramp-up, the project's coverage margin may improve to the point at which it would be in the borrower's interest to refinance the flexible payment loan with lower-cost debt sold in the municipal bond market.
The federal government could charge an origination fee to offset a portion of the budgetary cost of funding the loan.
The two central features of the loan (junior-lien on annual revenues and flexible payment schedule) should assist projects in obtaining investment-grade bond ratings on their senior indebtedness. This will facilitate a project's access to capital and reduce its cost of funding by elevating the rating on a significant portion of the project's debt.
The Alameda Corridor Project will be a 20-mile, high speed, high capacity and fully grade-separated freight transportation corridor linking the Ports of Los Angeles and Long Beach with the region's rail hub near downtown Los Angeles. Once completed, the project will reduce local congestion and expedite the nationwide delivery of freight.
The high cost of the project and its unusual revenue sources hindered its ability to obtain private financing without federal assistance, thus presenting a substantial barrier to completion. To address the complex financial needs of this nationally significant project, a $400 million federal loan is being used to support a financial package that includes funding from private, local, state, and federal sources. The provision of the loan on a junior-lien basis should enable lower-cost financing and instill greater investor confidence. The loan will be repaid from project revenues. The loan was "scored" at a $59 million budgetary cost to the federal government, based primarily on estimated default risk. This represents a leveraging ratio of more than 35 to 1, based on total transportation investment per dollar of federal budgetary cost of credit assistance. (See Appendix D for a more complete case study.)
Loans guaranteed by the federal government under a credit program should have the same basic features as the direct, flexible payment loans:
Loan guarantees would help meet the needs of revenue-backed project financing by encouraging junior-lien, flexible payment loans which enhance the coverage margin and creditworthiness of the senior capital markets debt. Just as the federal government directly funded the junior loan for the Alameda Corridor Project and enhanced the project's ability to issue senior debt, loan guarantees on junior obligations could also help facilitate the placement of the balance of the project's debt financing.
By providing a AAA caliber investment at taxable yield levels, loan guarantees should help attract participation by investors such as pension funds, which are well-capitalized enough to absorb the liquidity and time horizon risks, but which historically have not been active in funding domestic infrastructure.
In order to encourage the development of a junior-lien private market over time, the credit program might give preference to loan guarantees over flexible payment loans, all other things being equal. For the same reason, it might also make sense to limit guaranteed lenders to large, institutional investors, who are more likely to develop the expertise to some day assume the role of junior-lien lender without federal participation.
A standby line of credit represents an agreement by the federal government to make one or more direct loans to a project in future years, if needed to fund revenue shortfalls. It is a standby line in that it represents a contingent secondary source of capital in the event of certain deficiencies.
In contrast to the flexible payment loan or loan guarantee, the standby line of credit would not be used to fund construction costs as part of the project's initial capitalization. Rather, the line is a supplemental source of reserves that could be drawn on if needed to pay debt service during the project's ramp-up phase. The line should facilitate a project's access to private capital by enhancing coverage, thereby assisting the borrower in obtaining investment-grade ratings on its senior bonds.
The standby lines would differ from loan guarantees in several respects. They would run to the borrower, not the lender; they would cover only a portion of the bond issue; and they would be available for only a limited period of the issue's outstanding life. As such, the standby lines would not in themselves allow an issue to achieve a AAA rating (as in the case of the loan guarantee), but they should elevate a marginally-ratable issue to lower investment-grade status.
Draws on standby lines of credit might have various limitations, including:
Although a contingent federal loan in the form of a standby line of credit might not be construed as a federal guarantee of any other project debt for purposes of the Internal Revenue Code, separate corrective tax legislation could required in order to enable bond counsel to render an unqualified legal opinion as to the tax-exempt status of debt obligations benefiting from such assistance. (See Appendix B: Proposed Tax Code Modification for Standby Lines of Credit.)
Orange County, California is one of the most populous and auto-dependent areas in the nation, with transportation corridors supporting substantial domestic and international trade. The Transportation Corridor Agencies (TCA) are multi-jurisdictional authorities charged with the planning, construction, and operation of new toll road facilities in Orange County. To date, TCA has financed two new toll roads: San Joaquin Hills Corridor, a 14.5-mile, limited access highway in southwestern Orange County and Foothill/Eastern Transportation Corridor, a 51.7-mile highway providing direct access between Riverside County's residential areas, Orange County's southeastern suburbs, and I-5 near the San Diego County border.
To finance the construction of the TCA toll roads, two bond issues have been sold, each raising in excess of $1.1 billion. To support the complex financial needs of the TCA toll roads, Congress authorized DOT to provide a $120 million line of credit for the San Joaquin Hills Corridor and a $145 million line of credit for the Foothill/Eastern Transportation Corridor. The standby lines of credit assisted the two projects in obtaining BBB ratings on their initial bond issues, and helped the San Joaquin Hills Corridor secure bond insurance on its recent refunding in September 1997.
These standby lines of credit are available for up to ten years following the completion of each project and may be drawn down at the rate of ten percent of the line per year. Draws may be used to service debt, pay operations and maintenance costs, or fund capital repairs. If the contingent federal funds are drawn upon, full repayment is anticipated from project revenues. The standby lines of credit have been "scored" at a total of $17.6 million budgetary cost to the federal government, based on default risk. This represents a leveraging ratio of more than 150 to 1 in terms of total transportation investment per dollar impact on the federal budget. (See Appendix D for a more complete case study.)
Under a development cost insurance program, the federal government could insure a portion of the pre-construction costs incurred by a development team and require substantial risk-sharing by other parties. The program could offer the following features:
Development cost insurance could be available only for a development team that had received a mandate from a government project sponsor to build a project that satisfied the defined criteria for projects of national significance. (Only costs incurred after selection of the development team by the government sponsor would be covered.)
The federal share could be limited to 40 percent of pre-construction costs and could be further capped at some predetermined amount (e.g., $4 million per project).
To ensure shared risk-taking and establish significant financial and political discipline the government sponsor could be required to insure at least 20 percent with the balance being borne by the development team.
The coverage could be claimed at the end of five years if the project had not proceeded to construction; however, if the project did advance at a later date, the federal insurance payment would be reimbursable.
The federal government could collect up-front insurance premiums upon execution of the policy to offset a portion of the budgetary cost of the program.
In most cases, development cost insurance would be available for projects incurring pre-construction costs that would otherwise be eligible for outright federal grants if they were being developed under conventionally funded public procurements. The projects typically are developed as public/private partnerships precisely because there are funding constraints to traditional approaches. It is appropriate, therefore, that these developmental costs be eligible for partial insurance coverage under the program.
In essence, the concept represents a domestic version of the Overseas Private Investment Corporation (OPIC). OPIC insures American companies against the political risks associated with investing in foreign countries. The development cost insurance program would insure selected development teams against domestic political or policy change risk as well as other pre-construction risks.
The flexible payment loan, loan guarantee, and standby line of credit are likely to be used by projects with different financial profiles. The flexible payment loan and loan guarantee will be most useful to those projects that must demonstrate to senior debt investors that there is adequate coverage on maximum annual debt service at the outset of the project. Project sponsors will find the flexible payment features attractive if the Treasury lending rate compares favorably to their own cost of capital on a junior-lien basis.
A standby line of credit is more likely to be used by projects that are able to demonstrate to investors that their revenue streams and resulting coverage margins are likely to grow substantially over time. It should prove particularly attractive to projects that are able to raise most of their debt financing on a tax-exempt investment-grade basis. It will allow such projects to issue senior debt on favorable terms with an ascending debt service pattern, but still have access to contingent or secondary sources of capital in the event revenues do not grow as quickly as annual payments of principal and interest during the ramp-up period.
Development cost insurance could be used by a variety of projects during the pre-construction phase to insure a portion of the expenses incurred by the project developer.
A project sponsor seeking federal credit will determine which of the credit products best meets its needs based on the project's financial structure and cost of capital. As noted above, a credit program might give preference to loan guarantees over direct loans, all other things being equal, in order to encourage the active participation of private investors in junior-lien financing. This may help familiarize them with the payment features of such obligations and help develop a non-guaranteed marketplace.
1 See Appendix A: A Risk Assessment Model for Federal Credit.
2 Suppose under a federal credit program, that a direct federal loan could not exceed 33 percent of total project costs and that the expected loss due to default was ten percent of the loan. For a $100 million project the federal loan would be $33 million, and the expected loss would be $3.3 million. The federal leverage ratio of total capital investment to the face value of the loan would be 3 to 1, and the federal leverage ratio of total capital investment to the budgetary cost of the loan (to account for the default risk) would be 30 to 1.
3 Through special federal appropriations in fiscal years 1993, 1995, and 1997, the San Joaquin Hills and Foothills/Eastern toll roads of the Transportation Corridor Agencies (TCA) in Orange County, California, obtained two ten-year standby lines of credit totaling $265 million, and the Alameda Corridor Project of the Alameda Corridor Transportation Authority (ACTA) in Los Angeles/ Long Beach received a direct federal loan of $400 million repayable over 34 years.
4 Although this type of financial assistance may not be considered a true credit product, it has similar characteristics and achieves similar goals and, therefore, is included in this study.
