China Environment Forum Value and Credit Mechanics of U.S. Government Sponsored Funding Models: The Clean Water and Drinking Water State Revolving Funds (“the SRFs”) Woodrow Wilson Center Jim Gebhardt, U.S. EPA November 17, 2015

Topics I.The State Revolving Fund Model: Program Value and Model Designs II. Credit Mechanics of Pooled and Single Borrower Financing Structures 2

The State Revolving Fund Model: Value and Design Its Value in Supporting National Clean and Safe Drinking Water Goals Funding secures Triple-A Market Access for States and Below Market Rate Financing for Local governments and other qualified borrowers Financial benefits provide a powerful inducement for local officials to secure SRF assistance to build prioritized projects 3

The State Revolving Fund Model : Value and Design SRF Program - Overall Model Design Federal Government annually capitalize state administered revolving funds subject to: – States contributing a minimum 20% matching share Funds are used to provide financial assistance from capital base including bonds secured by federal and state contributions 4

Basic SRF Financing Models States predominantly rely on: The Direct Financing Model which is limited to direct lending of federal and state contributions (program equity); and The Leveraged Financing Model which issues bonds secured by program equity and makes loans with borrowed proceeds and invests equity in additional pledged SRF loans or bond reserves 5

Basic SRF Model Cash Flows The Direct Financing Model ($100) State Matching Contributions (20% of Federal Draw) Annual Federal Appropriation State Revolving Fund Equity Account (includes Retained Earnings) SRF Financing Recipient(s) $100 of Financing Proceeds provided from Equity Account to Recipient for SRF Eligible Project Costs Repayments of principal and interest 6

Basic SRF Model Cash Flows Leveraging: Standard Reserve Model Assumption: $100 of Equity is Used to Secure $200 of Bonds Reserve model depends on availability of high quality investments. Benefits single borrower transactions that have weak bond ratings. Master Financing Indenture houses all bond series issued pursuant to its terms. Clean Water and Drinking Water Financing Program operate out of the same financing indenture and cross-pledge program assets to maximize credit value. State Revolving Fund Equity Account(s) (includes Retained Earnings) Private Investors SRF Bonds (Series 1 thru n) $100 deposits and releases of SRF Equity from pledged reserve as financings originate and are repaid $200 Exchange of Cash and Bonds With Investors as Bonds are Issued and repaid with 4% interest, inclusive of 4% interest on pledged reserve SRF Financing Recipient(s) $200 of Bond Proceeds for SRF Eligible Projects at 2% blended rate and recipient repayments of principal and interest Pledged Reserve Invested at 4% (net of arb. payments to Treasury) Master Financing Indenture Equity Bond Proceeds 7

Basic SRF Model Cash Flows Leveraging: Blended Loan Model Assumption: $100 of Equity is Matched with $100 of Bonds Blended Loan Model is not dependent on quality of third-party investments. Master Financing Indenture houses all bond series issued pursuant to its terms. Clean Water and Drinking Water Financing Program operate out of the same financing indenture and cross-pledge program assets to maximize credit value. State Revolving Fund Equity Account(s) (includes Retained Earnings) Investors SRF Bonds (Series 1 thru n) (4% Cost of Funds) $100 deposit with scheduled releases of SRF Equity from repayments as bond funded loans are repaid $100 Exchange of Cash and Bonds With Investors as Bonds are Issued and repaid with 4% interest SRF Financing Recipient(s) $200 exchange of Bond and Direct Proceeds for recipient loan at 2% blended rate and recipient repayments of principal and interest. Pledged Direct Loans (0% Cost of Funds) Master Financing Indenture Equity Bond Proceeds 8

SRF Financing Models: Sources & Uses Sources & Uses Direct Financing Model Leveraged Blended Loan Rate Model Leveraged Reserve Model Sources: Equity$100 Bond Proceeds$0$100$200 Total Sources$100$200$300 Uses: Investments Reserves/Escrow $100 Investment Fund SRF Loans$100$200 Equity Savings (available for additional project support) Total Sources$100$200$300 Project to Equity Ratio1:12:1 9

II. Multi-borrower and Single borrower Financings 10

Credit Designs and Bond Ratings Multi-borrower Pool Financings Program resources dominate bond rating determinations Loan participants are secondary provided there are many and they are largely investment grade Single borrower Financings Borrower’s credit rating dominates Program resources can add incremental credit value 11

Multi-borrower and Single borrower Financings Mulit-borrower Master Financing Indenture Indenture Master Financing Indenture with Series 1 to n and borrowers 1 to n 12 Multiple series of bonds issued under supplemental indentures are treated as one series of bonds with one portfolio of borrower loans for rating purposes. Equity investment in each series is cross-pledged to all other series upon scheduled release assuring deep over collateralization of bond debt service. Ratings agencies assign high value to large, diverse portfolios. Series 1 S2 S3 S4 S5 Series n

Pooled and Single Recipient Financings Program Credit Design with Dedicated Large Recipient Financing Indenture 13 State Revolving Fund Equity Account(s) MFI for Pooled Financings MFI(s) for Single Recipient(s) MFI – Master Financing Indenture Cross-Pledge of Releasing Equity. Cross-pledge gives bondholders subordinate lien on releases from respective indentures. Cross-pledge is a credit positive.

Pooled and Single Recipient Financings The Value of Developing Separate Financing Strategies for Large Single Recipients Pooled financings originated under Master Financing Indentures have allowed SRF Administrators to bundle loans from successive bond series into well diversified portfolios that merit triple-A rating designations The triple-A ratings are largely a function of the high level of collateral provided by the leverage factor and the distribution of credit exposure across many local government loan recipients relative to rating agency triple-A stressed loss assumptions However where a large recurring credit recipient is included in the financing indenture its’ credit could limit the pooled credit rating. – If the credit is strong (i.e., double-A or better) than the impairment of triple-A rating strength is low (Wisconsin and Rhode Island include large recipients in pooled financings). – If credit strength is not strong (i.e., >double-A) than pooled ratings are at risk of being capped at less than triple-A Dedicated indenture can isolate risk of any current or future large credit impact on the programmatic credit represented by the pool financing vehicle 14

Fully Integrated SRF Credit Design - “The Full Buildout” Equity Lien Structure That Accommodates Multiple Product Offerings Short and Long-Term Equity Investment Accounts Derivative Contract Obligations (Termination Payments) Outstanding Single Recipient MFI MFI - Senior Lien Bonds Commercial Paper MFI - Subordinated Lien (Third Party Guarantees) Equity Deposits to Equity Releases Deposited Back to Equity Accounts Equity Deposits to 15 Pro-rata Pledge of Available Equity to MFI Senior and Subordinate Liens MFI – Master Financing Indenture

Appendix Financial Assistance Authority Under the Clean Water and Safe Drinking Water Acts, as Amended USEPA Financial Advisory Board; Selected SRF Reports 16

SRF Financial Assistance Authority Under the Clean Water Act From Title VI, Section 603 (d) Except as otherwise limited by State law, a water pollution control revolving fund of a State under this section may be used only— (1) to make loans, on the condition that— (A) such loans are made at or below market interest rates, including interest free loans, at terms not to exceed the lessor of 30 years and the projected useful life (as determined by the State) of the project to be financed with the proceeds of the loan; (B) annual principal and interest payments will commence not later than 1 year after completion of any project and all loans will be fully amortized upon the expiration of the term of the loan; (C) the recipient of a loan will establish a dedicated source of revenue for repayment of loans; (D) the fund will be credited with all payments of principal and interest on all loans; and (E) for a treatment works proposed for repair, replacement., or expansion, and eligible for assistance under subsection (c) (1), the recipient of a loan shall – (i) develop and implement a fiscal sustainability plan… (2) to buy or refinance the debt obligation of municipalities and intermunicipal and interstate agencies within the State at or below market rates, where such debt obligations were incurred after March 7, 1985; (3) to guarantee, or purchase insurance for, local obligations where such action would improve credit market access or reduce interest rates; (4) as a source of revenue or security for the payment of principal and interest on revenue or general obligation bonds issued by the State if the proceeds of the sale of such bonds will be deposited in the fund; (5) to provide loan guarantees for similar revolving funds established by municipalities or intermunicipal agencies; (6) to earn interest on fund accounts; 17

SRF Financial Assistance Authority Under the Safe Drinking Water Act From Title XIV, Section 1452(f) Except as otherwise limited by State law, the amounts deposited into a State loan fund under this section may be used only— (1)to make loans, on the condition that- (A)the interest rate for each loan is less than or equal to the market interest rate, including an interest free loan; (B) principal and interest payments on each loan will commence not later than 1 year after completion of the project for which the loan was made, and each loan will be fully amortized not later than 20 years after the completion of the project, except that in the case of a disadvantaged community (as defined in subsection (d)(3)), a State may provide an extended term for a loan, if the extended term— (i) terminates not later than the date that is 30 years after the date of project completion; and (ii) does not exceed the expected design life of the project; (C) the recipient of each loan will establish a dedicated source of revenue (or, in the case of a privately owned system, demonstrate that there is adequate security) for the repayment of the loan; and (D) the State loan fund will be credited with all payments of principal and interest on each loan; (2) to buy or refinance the debt obligation of a municipality or an intermunicipal or interstate agency within the State at an interest rate that is less than or equal to the market interest rate in any case in which a debt obligation is incurred after July 1, 1993; (3) to guarantee, or purchase insurance for, a local obligation (all of the proceeds of which finance a project eligible for assistance under this section) if the guarantee or purchase would improve credit market access or reduce the interest rate applicable to the obligation; (4) as a source of revenue or security for the payment of principal and interest on revenue or general obligation bonds issued by the State if the proceeds of the sale of the bonds will be deposited into the State loan fund; and (5) to earn interest on the amounts deposited into the State loan fund. ` 18

SRF Credit Design and Product Optimization Select SRF Reports USEPA Financial Advisory Board “Utilizing SRF Funding for Green Infrastructure Projects,” January 2014; “SRF Investment Function: Current Status and Prospects for Enhancing SRF Sustainability,” February 2011; and “Relative Benefits of Direct & Leveraged Loans in SRF Programs,” August See: www2.epa.gov/efab/envirofinance/publications#srfs 19

Contact Information Contact Information (202) (O) (202) (C) Water Finance Center Website: water.epa.gov/infrastructure/waterfinancecenter. cfm