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4. Funding a Surface Transportation Credit Program
Introduction
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.
Background on Federal Assistance under Credit Reform
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.
The Cost of Credit for Surface Transportation
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.
The Leveraging Potential of a Credit Program
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:
- Column A – Cost of Typical Project: For the loan products (flexible payment loans, loan guarantees, and standby lines of credit), major projects of national significance are assumed to cost an average of $500 million each. Although recent projects authorized to receive credit assistance have been significantly larger (both Orange County TCA toll roads cost well over $1 billion and the Alameda Corridor costs over $2 billion), such projects more commonly may be in the $100 to $500 million range. Pre-construction costs of large infrastructure projects eligible for development cost insurance are assumed to average $5 million.
- Column B – Federal Participation Ratio: As described in Chapter 2, credit assistance in the form of direct loans, loan guarantees, and lines of credit would be limited to no more than 33 percent of total project costs. This limitation would ensure market discipline, leverage scarce federal resources with significant private capital, and minimize costs and risks to the government. The federal insurance ratio is limited to 40 percent of pre-construction costs if an eligible project fails to advance to construction. The state would cover 20 percent of costs eligible for reimbursement, and if it wished, could also assume all or part of the 40 percent developer share.
- Column C – Amount of Credit per Project: The nominal or face value of credit assistance provided to a project sponsor is simply the product of project cost and participation ratio.
- Column D – Average Subsidy Rate per Project: The subsidy rate represents the portion of credit assistance estimated to be unrecovered because of defaults.4 The eight percent rate assigned to flexible payment loans, loan guarantees, and standby lines of credit is a weighted average of the estimated capital charges that would be required for recipient projects. This rate was derived from a scoring methodology similar to that used by rating agencies to assess reserve requirements for bond insurance companies.5 Federal credit assistance is assumed to enable at least 80 percent of recipients to attain the investment-grade rating of BBB, which has a capital charge or subsidy rate of five percent. The remaining 20 percent of recipients are assumed to achieve at least the sub-investment-grade rating of BB, which has a capital charge or subsidy rate of 20 percent. It is worth noting, however, that the model used to assign capital charges is based on historical default rates for start-up toll road projects. Therefore, the capital charges used in this report are merely a proxy for other types of surface transportation infrastructure projects. The actual capital charges for projects other than start-up toll facilities may be higher or lower depending on those projects' financial structures and risk profiles. Additional research will be required to ascertain those charges. The 50 percent estimated subsidy rate for development cost insurance illustrates the assumption that half of participating projects would not proceed to construction and would require partial reimbursement of eligible pre-construction costs.
- Column E – Average Subsidy Cost per Project: The subsidy cost of a project equals the product of the credit amount and the subsidy rate. It measures the true cost to the government of providing credit assistance and is the basis for calculating budget totals.
- Column F – Number of Projects per Year: Table 4.1 assumes that, on average, seven major projects of national significance would be eligible for and funded with flexible payment loans, loan guarantees, or standby lines of credit each year. A development cost insurance pilot program could be funded at $8 million per year, which under the assumptions in Table 4.1 would support eight major projects each year.
- Column G – Budget Authority (Subsidy Cost) per Year: The annual budget authority required to fund the credit program – excluding the funding needed to cover administrative costs – is the product of the subsidy cost per project and the number of projects. Under the assumptions in Table 4.1, this amount is $100 million. (It is estimated that federal costs associated with credit policy, oversight, origination, extension, and other administrative activities might total $1 to $2 million per year for a $100 million annual program.)
- Column H – Face Value of Credit per Year: The annual face value of credit assistance is the product of the amount of credit per project and the number of projects per year. Under the assumptions in Table 4.1, the credit program would extend nearly $1.2 billion of nominal assistance each year at a budgetary cost of $100 million. Comparing the totals for Column G (subsidy cost) and Column H (face value of credit), the federal credit program results in an eight percent budgetary impact compared with 100 percent for an equivalent amount of grant assistance.
- Column I – Non-Federal Investment per Year: Assuming that recipients receive the maximum level of assistance possible (33 percent for loan products and 40 percent for development insurance), Table 4.1 shows that the $1.2 billion of federal credit would be leveraged with nearly $2.4 billion of private and other non-federal capital.
- Column J – Total Capital Investment per Year: The total amount of capital invested each year represents total project costs and is the sum of federal credit and non-federal capital. Note that for loan guarantees and standby lines of credit, total project capital would equal non-federal investment, since these instruments are contingent or secondary sources of funding. Table 4.1 shows that annual capital investment of more than $3.5 billion could be generated by $1.2 billion of credit assistance at a budget cost of $100 million. Those amounts lead to leveraging ratios of 3 to 1 for total capital investment to face value of credit assistance and 35 to 1 for total capital investment to subsidy cost of credit assistance.
Budget Authority to Fund Credit Assistance
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.
The Provision of Separate Contract Authority
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.
The Use of Existing Unobligated Balances
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:
- Budget Authority – Legislation would authorize the obligation of prior-year apportionments (current unobligated balances) of federal-aid highway funds for paying the subsidy costs of credit assistance. Use of this existing contract authority would be limited to $100 million per year. This amount would represent "new" obligation authority in addition to the "regular" obligation authority provided annually in appropriations acts for the federal-aid highway program.
- Funding Source – As with other contract authority programs, the credit program would be funded from the HTF. Sufficient resources (tax revenues and interest income) would be provided through authorizing legislation to liquidate any contract authority that would be obligated for the subsidy costs of federal credit.
- Spending Category – If the use of unobligated balances to pay credit program subsidy costs were exempt from annual limitations, the resulting outlays (cash expenditures) would be considered mandatory spending subject to pay-as-you-go budget rules.6 This would be similar to the current treatment of FHWA's Minimum Allocation, Emergency Relief, and Demonstration Project spending. On the other hand, if the use of unobligated balances were made subject to annual limitations, the resulting outlays would be considered discretionary spending subject to annual discretionary caps.7 In this case, the credit program would compete directly with most other federal transportation programs – which are categorized as discretionary – for limited resources within the discretionary caps.
- Cost Allocation – The budgetary or subsidy cost of credit provided to a selected project would be charged to the appropriate state's unobligated balance of previous apportionments. New apportionments of federal-aid funds would not be affected.
- Deficit Impact – Additional outlays (to pay the subsidy costs of credit assistance) would occur under this approach, even though existing budget authority would be used. Any funding mechanism that provides for additional outlays that are not offset by reductions elsewhere would have a deficit impact, regardless of the source of budget authority. It is worth noting again, however, that credit assistance has a fractional budget impact (eight percent in Table 4.1) compared with an equivalent amount of grant assistance.
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.
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Table 4.1 Credit Program Estimated Budgetary
Costs and Investment Amounts
(dollar amounts in millions) |
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Proposed |
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 Investement per Year |
J = H + I Total Capital Investment per Year |
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| 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.
