The continued growth of the U.S. economy depends, in large part, on a comprehensive and interconnected nationwide surface transportation system. The nation's growing population and increased shipping demands are straining the capacity of existing facilities. The federal-aid grant program has enabled the construction of an extensive transportation system; however, the program's financial limitations are becoming evident in the face of growing investment needs and the lack of available public funding to meet those needs. This funding shortfall is particularly acute for large new investments and major expansions of existing highways and other transportation facilities, the costs of which can amount to hundreds of millions of dollars each.
Federal assistance in the form of credit (direct loans, loan guarantees, and other lending arrangements) rather than outright grants is currently being used to stimulate investment in such sectors as housing, education, and agriculture. Federal credit has achieved important social and economic goals in these areas (e.g., affordable housing, universal access to higher education, and a stable food production system). A federal credit program oriented toward large surface transportation projects of national significance could be an important tool in helping close the current funding gap and supporting the national economy in an era of constrained public resources.
Although receipts from transportation-related excise taxes have been growing at a steady rate, federal budgetary constraints limit the amount of grant assistance that can be distributed to the states. The primary form of federal assistance - the federal-aid program - reimburses state capital expenditures on transportation infrastructure at prescribed rates (historically, up to 80 or 90 percent); the remainder of project costs is covered by the states. Sole reliance on a grant-based reimbursement program may no longer be the most productive approach for funding certain large infrastructure projects. This approach is limited in range, slow to accommodate change, and unable to leverage sufficient private and non-federal capital to meet growing investment needs.
A federal credit program for surface transportation projects could complement existing federal-aid grants by directing resources to transportation investments of critical national importance that otherwise might be delayed or not constructed at all because of risk, complexity, or scope. Federal credit could encourage more private sector and non-federal participation, address important public needs in a more budget-effective way, and take advantage of the public's willingness to pay user fees in order to receive the benefits and services of transportation infrastructure sooner than would be possible under traditional, grant-based financing.
The overarching goal of a surface 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. In addressing the needs of large transportation investments, such a program should be designed to achieve six key objectives.
A key objective of any federal credit program should be to facilitate the borrower's access to the private capital markets by overcoming market imperfections. Large, complex start-up projects frequently encounter market resistance as a result of investor concerns about investment horizon, liquidity, predictability, and risk. This is particularly the case for subordinate and secondary sources of capital. The federal government is uniquely qualified to fill the role of a patient investor, willing to accept a long-term return in order to help advance projects providing substantial benefits to the nation's economy. There may be an appropriate federal role for a carefully defined credit program to fill these gaps until the capital markets develop greater capacity to absorb these risks. Addressing these risks would reduce the transactional friction associated with large and complex project financings which is reflected in unnecessarily large reserve requirements, coverage margins, capital costs, and transaction fees.
A credit program should be designed to assist transportation projects that are large-scale capital investments generating major economic benefits, such as trade corridors, intermodal facilities, international border crossings, and Intelligent Transportation Systems (ITS). The sum of public and private benefits would be expected to substantially exceed project costs. Given their size, many of these projects cannot be readily funded through existing government assistance programs, including state infrastructure banks. A surface transportation credit program could offer a cost-effective mechanism for financing these important national investments.
A credit program should be designed to assist those projects capable of generating their own revenue streams. The revenues may come from direct user charges, such as tolls or fares, or indirect beneficiary fees, such as special benefit district assessments or local dedicated tax revenues. Using revenues from beneficiaries to support part or all of the capital costs is recognized as a more equitable and efficient way of funding such projects. By assisting state and local government sponsors in identifying new project-related revenue streams, a federal credit program would allow existing state and federal grant resources to be directed toward other, more traditional projects that lack the potential to become self-sustaining.
A credit program should seek to minimize the risk to the federal government of borrowers defaulting on their repayment obligations. A key element in reducing risk involves limiting the federal role to that of a minority investor (financing not greater than 33 percent of project costs). The majority investment of private capital would instill market discipline by forcing the selection of only those projects that are financially feasible and have acceptable risk profiles. Program rules should be established to ensure that project risks are assessed and scored against the federal budget in a realistic and conservative manner. The risk assessment should be based on credit analysis techniques used by the capital markets in assessing the default risk of similar infrastructure loans.
To date, federal credit activities in the surface transport sector have been characterized by ad hoc efforts. For example, Congress in recent years has passed several pieces of special legislation assisting three major projects in California. However, the success of these transactions has stimulated considerable interest and created demand for a program structure accessible to a broader range of projects. An important objective of a surface transportation credit program, therefore, should be to establish uniform, objective, and transparent criteria for states, local governments, and other sponsors to submit applications for credit assistance, and to set forth an orderly process for evaluating, selecting, and funding projects.
More than other types of federal credit activities, large infrastructure projects depend on state and local government approval and support. A federal credit program for surface transportation projects should draw on the active involvement of state and local governmental units throughout the entire process, from the initial identification of suitable candidates to the ongoing monitoring and servicing of the credit products.
A surface transportation credit program could offer four distinct types of assistance to manage the different financial needs of projects at various points in their life cycles.
Given the uncertainty of projected revenue streams and operating costs for start-up transportation projects, investors may require an unusually high coverage margin for debt service. The excess coverage constrains the permitted level of annual project debt service, which limits the amount of debt that can be issued.
Flexible payment loans would be direct loans from the United States Department of Transportation (DOT) to project sponsors to provide long-term, fixed-rate financing of a portion of construction costs. The flexible payment loan could be in an amount up to 33 percent of the cost of a project and have a final maturity date as long as 35 years after construction is complete. The interest rate on the flexible payment loan would be set at a level equal to comparable-term U.S. Treasury bonds.
The loan would be repayable from project-related revenues. The terms and conditions of each loan would be negotiated between the federal government and the borrower, but would enable the federal government to accept a claim on revenues junior to the project's other senior indebtedness. In the event of default, the loan would have a parity or co-equal claim on project assets with other investors. If project revenues were insufficient to meet current debt service on the loan, interest and principal payments could be deferred.
The flexible payment loan would enable the senior debt to demonstrate higher coverage margins and attain investment-grade bond ratings. This, in turn, would facilitate project access to private capital.
Loan guarantees by the federal government to private lenders would be designed to attract private capital on similar terms to direct loans. The guarantees could be limited to loans from large institutional investors who would be better-equipped to absorb the timing uncertainty of loan repayments.
A loan guarantee could apply to subordinate debt and be capped at 33 percent of total project costs. In the event net revenues were insufficient to meet scheduled debt service on the guaranteed loan, repayments could be deferred for a pre-determined period of time, as with the flexible payment loan. Because the federal government would fully guarantee debt service repayments over the life of the loan, interest payments would be taxable, consistent with federal tax law. A full faith and credit guarantee of the United States should command a "AAA" rating, making such loans attractive to large purchasers of taxable debt securities. Potential investors would include public, private, and union pension plans, which to date have not been active in financing domestic infrastructure projects.
Loan guarantees of this nature would help meet the need for patient capital for revenue-backed project financing by encouraging junior-lien, flexible payment loans that enhance the coverage and creditworthiness of the senior capital market debt. As investors in guaranteed loans become more familiar with the repayment characteristics of junior start-up debt, it may ultimately be possible for them to take on the role of providing junior-lien credit for surface transportation projects without a federal back-up. This would support the program's principle of developing private credit sources to supplant the federal role.
In certain cases, investors may recognize that a project is likely to experience growth in its revenue stream over time, but they may be uncertain about the timing of the growth, especially during the ramp-up period in the years following project completion. The standby line of credit would fill a gap by providing a secondary source of capital during this critical phase of initial project utilization.
The line of credit would take the form of a government commitment to make one or more flexible payment loans in the future, if needed. The total line could not exceed 33 percent of project costs, and would be available for draws only during the ten-year ramp-up period following project completion. Up to 20 percent of the line could be loaned in any given year, and any draws would need to be repaid from project-related revenues within 35 years from project completion. These contingent loans would be structured in a similar manner to the direct flexible payment loans.
The standby line of credit is intended to assist marginally-ratable projects in attaining investment-grade bond ratings and securing bond insurance.
The pre-construction phase of project development is the most speculative stage. During this stage, the project sponsor must complete environmental reviews, secure permits, perform feasibility studies, and carry out various other preliminary tasks required for constructing the facility.
For traditional public projects, these costs routinely are borne by state or local governmental sponsors. For public/private partnerships, these costs often are required to be advanced largely by private developers. However, developers are becoming increasingly reluctant to finance pre-construction costs because of the large exposure, long lead times, and political risks involved.
Development cost insurance would provide federal reimbursement to a project sponsor for a portion of the pre-construction development costs in the event the project failed to proceed to construction. The federal amount of the insured development expenses could be capped at some pre-determined level (e.g., $4 million per project). Additionally, the federal share should be limited to 40 percent of covered costs, and the government sponsor should be required to insure at least 20 percent in order to instill significant financial and political discipline. Up-front insurance premiums would be collected upon execution of the policy, thus offsetting a portion of the budgetary cost of the program. A claim on the insurance could be made 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. A relatively small portion of a credit program's budgetary resources - perhaps no more than ten percent - could fund a pilot program that would effectively demonstrate the potential of development cost insurance.
To be considered for federal credit assistance, project sponsors would submit applications to DOT and undergo a review and selection process. The first step in the evaluation process would be to determine whether a project meets certain objectively measurable criteria. These initial threshold criteria would include project purpose, project size, whether benefits exceed costs, evidence of state and local support, and the potential for user charges or non-federal revenues. Qualified projects meeting the threshold eligibility criteria then could be evaluated and selected based on the extent to which they meet various qualitative criteria, such as promoting innovative technologies, demonstrating creditworthiness, solving special transportation needs, and fostering public/private partnerships.
In recognizing the need for a stable and predictable source of funds for multi-year surface transportation projects, Congress has legislated the use of contract authority for the federal-aid highway program since 1921. Under contract authority, sums authorized are available for obligation in advance of annual appropriations.
To facilitate the planning and structuring of large project financing arrangements involving federal credit assistance, program funding levels should be known in advance. Providing specified amounts of contract authority, rather than annual appropriations of budget authority, would ease market concerns about the availability of future funds and enable DOT to better allocate resources and avoid costly delays in committing federal credit assistance.
The commitment of federal credit assistance would require stable funding levels known in advance even more than the commitment of traditional grant reimbursements. Project candidates for federal credit assistance would tend to be larger, their financial structures would be more complex, and the majority of their funding would come from private capital predicated on the timely and assured receipt of federal credit.
A further refinement could allow states to utilize their unobligated balances of prior-year federal-aid apportionments as a source of contract authority to pay the subsidy costs of credit assistance.
The traditional federal-aid grant program, which typically allows federal contributions of up to 80 percent of total project costs, has an implicit leveraging ratio of 1.25 to 1. A surface transportation credit program could provide meaningful assistance to certain large infrastructure projects with federal participation of no more than 33 percent of project costs. And the budgetary cost of the credit assistance, based on rating agency risk assessment models and prevailing averages for existing credit programs in other sectors, might be less than ten percent of an equivalent amount of grant assistance.
Under the federal credit program structure outlined in this paper, annual capital investment of more than $3.5 billion could be generated by $1.2 billion of federal credit assistance at a budgetary cost of only $100 million. Those amounts represent a leveraging ratio of 35 to 1 in terms of total capital investment to budgetary resources consumed.
A surface transportation credit program would need to address certain federal credit and tax policy issues, especially as they relate to subordination and tax-exempt debt, since many of the recipient projects would be eligible for municipal bond financing.
Under the Internal Revenue Code, there is no provision that prohibits the use of tax-exempt debt simply because a portion of project costs is financed with federal funds (including direct loans). In fact, it is quite common for state and local project sponsors to finance surface transportation facilities with a combination of federal grant assistance and proceeds of tax-exempt debt.
The federal credit program structure outlined in this paper is consistent with most OMB directives on credit assistance, including the requirement of a parity claim on assets in the event of borrower default. Implementation of such a program, however, would require waiving a policy against the subordination of direct loans to the claim of tax-exempt obligations on annual project revenues. Subordination in the form of a junior lending position would be essential if the credit program were to meaningfully assist project sponsors in accessing the capital markets for the preponderance of their financing needs. Moreover, in the opinion of a major rating agency, a junior position does not increase the effective long-term risk associated with extending credit to transportation facilities.
The flexible payment loan in many cases would involve the side-by-side coexistence of direct loans with tax-exempt obligations of state and local governments, but would not involve direct or indirect federal guarantees of those tax-exempt obligations.
Tax-exempt debt is prohibited from being supported by federal loan guarantees. Section 149 of the Internal Revenue Code provides that any obligation that benefits from a direct or indirect federal guarantee, either in whole or in part, is deemed taxable; the interest payments to investors would not be exempt from federal income taxation.
Federal loan guarantees under a surface transportation credit program would not be used to guarantee tax-exempt senior bonds. However, they could be used to secure taxable junior-lien financing where other project debt was issued on a tax-exempt basis. As taxable instruments, the guaranteed loans themselves would comply fully with Section 149. But as with the direct loan program, the loan guarantee program would require a waiver from OMB policy prohibiting the subordination of federal credit to tax-exempt obligations, since in many cases the senior project debt would be municipal bonds.
The language in Section 149 of the Internal Revenue Code is so absolute (any direct or indirect guarantee in whole or in part) that the standby lines of credit could be viewed as indirect federal guarantees under current tax law. Consequently, bond counsel might not be able to render an unqualified opinion as to the tax status of bonds secured by a federal line of credit.
One way to ensure that a standby line of credit does not undermine the tax status of tax-exempt debt is to revise the Internal Revenue Code to state that a standby line of credit does not constitute a federal guarantee.
Alternatively, if the purpose for which a standby line of credit can be used is broadened to include other costs, such as extraordinary repair and replacement and operation and maintenance, in addition to debt service, the implication of a federal guarantee may be sufficiently diluted to allow bond counsel to render an unqualified legal opinion. The Transportation Corridor Agencies used this approach in conjunction with the standby lines of credit for their two toll road projects in southern California which were financed with tax-exempt debt.
Federal credit and tax policies pertaining to subordination and tax-exempt debt should not be applicable to any federal payments under a development cost insurance program, since these pre-construction expenses generally are funded with developer equity.
In a fiscal environment of constrained public resources, it has become increasingly difficult to fund major transportation projects. Yet in many cases, these are precisely the types of infrastructure investments which produce the greatest economic benefits to the nation. These facilities also tend to have the potential to generate their own revenue streams, allowing them to be funded with project-based debt.
A surface transportation credit program could address the need for supplemental and subordinate capital in a highly budget-effective manner. It could enable large projects of national significance to gain significant market access with only a limited federal investment, thus leveraging substantial multiples of capital from private and other non-federal sources. Such a credit program could also help states conserve their customary federal-aid grants for smaller, but more numerous, traditional state and local projects that cannot be supported through user charges or other dedicated revenue streams.
