This chapter discusses the federal budgetary resources needed to fund the various credit products - flexible payment loans, loan guarantees, standby lines of credit, and development cost insurance. It reviews the budget scoring of federal credit, summarizes a methodology for estimating the cost of credit for surface transportation, illustrates the amount of investment that could be leveraged through a federal credit program, and outlines how to provide budget authority to fund such a program. It includes a discussion of how paying for the costs of federal credit assistance could be accomplished through either the provision of separate contract authority or the use of unobligated balances of federal-aid highway funds previously apportioned to the states.
Federal credit encompasses financial assistance other than grants provided by the federal government, such as direct loans and loan guarantees. The Federal Credit Reform Act of 1990 (FCRA) governs the provision of federal credit assistance. The stated purposes of FCRA are to:
Measure more accurately the costs of federal credit programs;
Place the costs of credit programs on a budgetary basis equivalent to other federal spending;
Encourage the delivery of benefits in the form most appropriate to the needs of the beneficiaries; and
Improve the allocation of resources among various credit programs and between credit and other spending programs.
Before credit reform (through fiscal year 1991), the costs of federal credit programs were based on the cash flows associated with loans and guarantees. Thus, the budgeted cost of a direct loan was recorded as the amount of cash disbursed to the borrower at the time of disbursement, regardless of subsequent repayments. The budgeted cost of a loan guarantee was recorded when fees were collected or when cash outlays were made to pay for defaults, regardless of when the federal commitment was made. This cash-based budgeting overstated the costs of direct loans and understated the costs of loan guarantees at the time of federal commitment, compared with grant expenditures.
Under FCRA (beginning in fiscal year 1992), the true budgetary or "subsidy" costs of providing federal credit depend on the estimated default risks and interest subsidies (the extent to which interest rates charged are less than the rates on comparable Treasury securities) and are recognized or "cored" up front, when the federal commitment is made. Together, these credit subsidy costs provide a more accurate economic indicator of the federal resources consumed in offering assistance. Therefore, unlike other federal spending, the budgeting for credit assistance is based on estimated subsidy costs rather than actual cash flows.
While the subsidy costs of loans and guarantees are included in the budget totals when those commitments are made, the net cash flows associated with various credit transactions (such as loan disbursements and receipts) are recorded outside the budget totals as a means of financing. This budgetary treatment allows the costs of credit to be compared directly with those of grants. For example, the disbursement of a $100 loan has the same cash effect as the disbursement of a $100 grant; however, if $90 of the loan eventually will be repaid with interest, the true cost of the loan is only ten dollars, or ten percent of the cost of the grant. Regardless of the face value of credit provided, the true cost to the government is the net present value of amounts not reimbursed due to either defaults or subsidized interest.
The federal government currently provides credit assistance through a variety of national programs that collectively address numerous policy goals such as access to higher education, affordable housing, disaster assistance, farm credit, and rural electrification. The face value of the credit assistance outstanding through these programs totaled $970 billion ($165 billion in direct loans and $805 billion in loan guarantees) in 1996. This number excludes more than $1.7 trillion in credit assistance offered through Government Sponsored Enterprises. In 1996, $198.8 billion in new federal commitments ($23.4 billion in direct loans and $175.4 billion in loan guarantees) was supported with $5.8 billion in subsidy budget authority; thus, the budget authority needed to protect against default averaged just 2.9 percent of the face value of credit. 1
In providing transportation credit assistance, the federal government shares the financial risks associated with advancing large, revenue-generating infrastructure projects. By and large, the federal government has not applied credit assistance to surface transportation investments. Currently, DOT's only significant involvement in credit programs is through the Maritime Administration providing loan guarantees to support shipbuilding. To date, nearly all federal highway and transit funds have been provided as grants either to reimburse costs incurred or, more recently, to capitalize pilot SIBs. The decision to offer credit assistance fundamentally is about whether, how, and to what extent the federal government should broaden the forms of assistance it offers to states to include credit in support of major transportation infrastructure investment.
A key issue for the federal government in extending credit is accurately estimating the budgetary impact of such assistance. As described above, estimating or "scoring" the budgetary cost of federal credit depends on the associated default risks and interest subsidies (if any). These factors determine the amount of budgetary resources that must be provided in either appropriations or authorizing legislation before the federal government can offer credit assistance. In accordance with budget scoring conventions, only the direct budgetary effects of credit assistance contained in proposed legislation should be scored. The various indirect budgetary effects - whether potential benefits generated by increased infrastructure investment and the resulting economic activity, or potential costs resulting from increased issuance of tax-exempt debt and the resulting revenue loss ("tax expenditure") - should not be assessed, as they are difficult, if not impossible, to agree upon and accurately quantify. 2
The techniques currently used by the federal government to assess the budgetary costs of federal credit offered by other agencies are not well-suited to evaluate transportation project financing. The budget scoring methods used for many programs (e.g., agriculture, business, housing, or student loans) are based on large volumes of historical data on small, individual credits that are essentially similar. In contrast, transport investments tend to be large one-of-a-kind transactions uniquely structured to meet each project's specific financial profile.
Except for toll roads, the financial community has relatively little experience with surface transportation projects that might be eligible to receive federal credit, including nationally significant intermodal facilities, high priority corridors, international border crossings, and projects involving the application of advanced technology and innovative public/private partnerships.
Rating agencies have decades of experience with toll roads, however, dating back before the Interstate construction era. Unlike consumer and small business loans, toll roads tend to be improving credits over time. Normally, long-term debt for toll roads is sold at the outset as combined construction and permanent financing; therefore, for project-related debt, the initial rating reflects construction risk (including delays arising from environmental and litigation risk) as well as traffic and operating performance risk. After construction is completed and traffic patterns have stabilized, the ratings tend to improve. Even toll roads that have initial traffic shortfalls ultimately should be self-supporting, as evidenced by the few defaulted toll roads that eventually became investment-grade as traffic grew to meet forecast capacity (e.g., the Chesapeake Bay Bridge-Tunnel, the Chicago Calumet Skyway, and the West Virginia Turnpike).
As an industry sector, toll revenue bonds have had an extremely low default rate compared to other borrower groups. Since 1961, defaults of debt issued to finance toll roads, bridges, and tunnels have totaled about one percent of the new issue volume in this field. Of the bonds that went into default, many were eventually refinanced and paid off in full so that actual unrecovered losses totaled only three-tenths of one percent of total new debt issued. 3 It is worth noting, however, that any estimated default rate for a specific project would vary according to numerous factors including the complexity of the project and the security of its revenue sources.
The best market-derived information on actuarial default risk for infrastructure loans is in the financial models used by rating agencies to evaluate the financial strength of municipal bond insurance companies. Agencies such as Fitch Investors Service, Moody's Investors Service, and Standard & Poor's use capital reserves criteria (which are much more stringent than the state-by-state insurance commissioner statutory reserve requirements) to determine the claims-paying ability of bond insurance companies (e.g., MBIA, AMBAC, and FGIC). It would be appropriate for a federal credit program to use the standards that capital market investors have accepted as being virtually risk-free - those imposed by the rating agencies to assign AAA ratings on the bond insurers' creditworthiness.
The proposed scoring approach would use a rating agency's preliminary risk assessment (which would take into account the project cash flows including the federal assistance) to estimate the budgetary cost of the credit. Based on the findings of the rating agency's credit analysis, the project would be assigned a capital reserve charge similar to the reserve requirements for bond insurers on like-rated bonds they guarantee. The capital reserve charge would cover default risk and would be expressed as a series of annual anticipated cash flows that would be discounted at the relevant baseline Treasury rates to derive a present value amount representing the expected budget cost. (For a more complete discussion of the scoring process, please review the analysis by Fitch Investors Service in Appendix A.)
This approach has the advantages of being market-based, calculated by independent third-party experts, and predicated on transparent and objective criteria. It would offer an accurate, conceptually sound approach for estimating the risk of large, complex, heterogeneous capital investments in transportation infrastructure.
Table 4.1 illustrates the significant amount of capital investment that could be generated with a modest level of federal assistance. It shows that $100 million of budget authority, for example, could support the annual provision of nearly $1.2 billion of federal credit and more than $3.5 billion of total investment, given certain assumptions. This represents a potent leveraging ratio of 35 to 1 in terms of capital investment induced to budgetary resources consumed.
The following bullets explain in detail how the column amounts in Table 4.1 are derived:
Before federal credit of any type can be extended, budget authority to fund the subsidy costs of that credit must be provided. There are several ways to provide budget authority, but those funding options are independent of credit program features. In other words, regardless of its specific components, a credit program requires budget authority that is sufficient to cover the subsidy costs of the credit assistance provided.
The analysis in Table 4.1 indicates that annual budget authority of $100 million would support annual federal credit assistance of $1.2 billion for major projects of national significance. Over a six-year period, an aggregate funding level of $600 million could support over $7 billion of credit for some 42 projects receiving flexible payment loans, loan guarantees, or standby lines of credit and another 48 projects participating in a development cost insurance pilot program under the assumptions in Table 4.1.
A straightforward funding approach would be to provide new contract authority for a credit program to cover its subsidy costs. As discussed in Chapter 3, contract authority funded from the HTF is the ideal way to finance credit assistance for transportation infrastructure. It would provide a stable source of budget authority, known in advance, that would facilitate the planning, development, evaluation, and selection of candidate projects. Such contract authority would also allow the timely disbursement of credit assistance that is critical to the successful financing of these large, complex public/private ventures. Using the HTF to pay for transportation investments would also be consistent with the intended purpose of federal user fees dedicated to that fund.
An alternative funding approach would be to utilize existing contract authority in the form of states' "unobligated balances." These balances of unobligated contract authority are the result of annual controls (obligation limitations) imposed by the federal government to constrain spending and reduce the deficit. Congress generally authorizes highway funding, in the form of multi-year contract authority, based on tax revenues estimated to be credited to the HTF. Then DOT annually apportions (distributes by statutory formulas) most of that contract authority to the states. But the annual spending controls, which typically apply to about 90 percent of highway funding, usually prohibit the states from obligating the entire amounts apportioned to them for a given year.
Over the course of the ISTEA authorization period (fiscal years 1992-1997), the states received apportionments of federal-aid highway funds totaling $103.4 billion. Of that amount, $97.4 billion was subject to annual obligation limitations. As a result of those spending controls, the states were able to obligate $93.6 billion (96 percent) of their apportionments by the end of fiscal year 1997. Therefore, after accounting for the $5.9 billion unobligated balance that existed at the start of the ISTEA period (end of fiscal year 1991), the states had a total unobligated balance of apportionments subject to annual obligation limitations of $9.7 billion at the end of the ISTEA period (end of fiscal year 1997).
The states have grown increasingly frustrated with their inability to spend down or access that growing balance because of annual spending controls. It would be possible to structure the credit program funding mechanism to enable states to use their unobligated apportionments to fund the budgetary costs of credit assistance. Key aspects of this funding approach would include:
Because this funding approach leverages existing budget authority with significant private capital, it might be viewed favorably by the states as allowing additional spending that otherwise would not occur. In allocating limited resources among competing needs, the federal government can justify additional spending on transportation infrastructure only if it generates greater returns. Extending federal credit that enables private capital to make strategic transportation investments would be a much more effective use of unobligated balances than simply providing additional grants.
In addition, due to ongoing efforts to rein in federal spending and reduce budget deficits, it appears unlikely that annual spending limitations will be removed and states will be allowed to spend down their unobligated balances for regular grant reimbursements. Although some states harbor hopes that transportation spending will not be subject to certain budgetary constraints in the future (perhaps by taking the HTF off-budget), those prospects are uncertain. This approach would respond to states' long-standing concerns about growing unobligated balances and would operate within the existing budget framework to address critical investment needs - all at a relatively modest cost to the federal government.
Furthermore, charging states' unobligated balances for federal credit costs would be an equitable way of providing budget authority because states that benefited most directly from federal credit assistance would pay for those benefits with their own apportionments. States would submit applications for major infrastructure projects and signal their willingness to pay for the associated credit costs through reductions in their existing fund balances. Allowing the use of unobligated balances to pay for credit assistance would encourage states to seek out new resources in financing revenue-generating facilities. Also, it would not penalize states that chose not to participate; new federal-aid apportionments would not be affected.
1. Budget of the United States Government, Fiscal Year 1998, Analytical Perspectives, U.S. Government Printing Office, Washington, 1997.
2. Some might argue that a legislative provision containing federal credit for surface transportation should be assessed a tax expenditure budget score. This position contends that federal credit, to the extent it facilitates projects that issue tax-exempt debt for the balance of their costs, increases the overall volume of tax-exempt debt at the expense of taxable debt and consequently produces revenue losses for the U.S. Treasury. Others, however, could argue that this position appears to be inappropriate for several reasons: 1) Since credit program spending provisions do not contemplate any tax code changes, assessing a tax expenditure for federal credit would be an indirect cost scoring; 2) if indirect costs, such as revenue losses resulting from tax expenditures, are scored, then for consistency indirect benefits, such as revenue gains resulting from greater economic activity and additional taxable income, should be scored as well; and 3) to the extent that direct federal loans or federally-guaranteed loans fund a portion of projects that otherwise would be funded with tax-exempt debt proceeds, federal credit assistance would reduce the overall volume of tax-exempt debt and actually produce revenue gains for the U.S. Treasury.
3. According to data derived from the Bond Investors Association in 1997, there have been documented payment defaults on toll revenue bonds for only a half-dozen projects over the last 40 years. These defaults involved $412 million of bonds, or just over one percent of the $39 billion of "new money" (non-refunding) bonds issued to finance toll roads, bridges, and tunnels since 1961. Of the bonds that went into default, $297 million eventually were paid in full, with interest.
4. In the case of a standby line of credit, the subsidy rate represents the probability of any draws on the line not being recovered, rather than the probability of a draw, per se.
5. See the analysis by Fitch Investors Services presented in Appendix A for the derivation of this result.
6. Pay-as-you-go rules under the Budget Enforcement Act (BEA) require that all mandatory spending (not provided through annual appropriation acts) and tax receipts legislation enacted for a fiscal year be deficit-neutral in the aggregate. If Congress enacts mandatory spending or tax receipts legislation that is estimated to cause a net increase in the deficit, it must offset that increase by either increasing revenues or decreasing mandatory spending elsewhere in the budget in the same fiscal year.
7. Under the BEA, maximum amounts of new budget authority and outlays for discretionary spending (enacted through annual appropriation acts) are established each fiscal year. If Congress enacts appropriations that exceed those caps, a sequestration (cancellation of budgetary resources) is triggered to eliminate the excess.
| Table 4.1 Credit Program Estimated Budgetary
Costs and Investment Amounts (dollar amounts in millions) |
||||||||||||
| Proposed Product | A Cost of Typical Project |
B Federal Participation Ratio |
C = A * B Amount of Credit Per Project |
D Average Subsidy Rate per Project |
E = C * D Average Subsidy Cost per Project |
F Number of Projects per Year |
G = E * F Budget Authority (Subsidy Cost) per Year |
H = C * F Face Value of Credit per Year |
I = (A * F) - H Non- Federal Investment per Year |
J = H + I Total Capital Investment per Year |
||
| Loans, Guarantees, or Lines of Credit | 500 | 33% | 165 | 8% | /2 | 13 | 7 | 92 | 1,155 | 2,345 | 3,500 | |
| Development Cost Insurance | 5 | /1 | 40% | 2 | 50% | /3 | 1 | 8 | 8 | 16 | 24 | 40 |
| Annual Totals | 15 | 100 | 1,171 | 2,369 | 3,540 | |||||||
| 6-Year Authorization Totals | 90 | 602 | 7,026 | 14,214 | 21,240 | |||||||
| Leverage Factors: | ||||||||||||
| Ratio of Total Capital Investment to Face Value of Federal Credit | 3:1 | |||||||||||
| Ratio of Total Capital Investment to Subsidy Cost of Federal Credit | 35:1 | |||||||||||
/1 Pre-construction development costs relate to environmental permitting, preliminary engineering, feasibility studies, etc., incurred once a state has selected a preferred consortium to proceed with detailed plans. This presentation assumes that the federal government guarantees 40% of the pre-construction costs, the state guarantees another 20%, and the private consortium bears the remaining 40%. The actual construction costs likely would range from $100 - $500 million per project.
/2 This represents the likely budget scoring charge--as estimated by Fitch Investors Service--on projects receiving junior lien federal credit that have senior debt rated "BBB" to "BB" (4:1 weighted average). Projects that have senior debt rated exclusively "BBB" would have a scoring cost of only 5%. For illustrative purposes, this report uses the Fitch analysis of capital charges for startup toll facilities as a proxy for other types of surface transportation infrastructure projects.
/3 For risk-scoring purposes, this report assumes that half of projects assisted in the pre-construction phase would not proceed to construction.
