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Long-Term Financing

Long-term financing (or permanent financing as it is sometimes referred to) is usually necessary in order to distribute the cost of major capital improvements over many years. It is also sometimes useful for growing communities, where the authority can employ this method to distribute the cost over a larger population base over time. Low tapping fees and long repayment terms help shift the burden of paying for the needed facilities to a time when there are more people to share in their cost, and the construction of facilities with excess capacity can often encourage this growth. For communities with very stable or declining populations, however, the reverse is true. Higher tapping fees and shorter repayment terms are more appropriate since the maximum number of people to benefit from the project are currently living in the community.

Several sources of long-term financing are used in Pennsylvania , including different grants and loans. The loans have interest rates ranging from 1 percent per annum to whatever the current market demands, and the terms will vary from a short 10 years to a long 40 years. Descriptions of the various types of long-term financing available in Pennsylvania are described in the following sections.

Pennsylvania Infrastructure Investment Authority (PENNVEST)
PENNVEST is governed by a Board of Directors (which is chaired by the governor) and administered by the PENNVEST staff in conjunction with Pennsylvania Department of Environmental Protection. PENNVEST provides twenty year construction loans at subsidized interest rates based on the county unemployment rate, commonwealth cost of funds, and affordability factors. Interest rates may be as low as 1 percent but are subject to increase to a predetermined rate after five years.

An application for construction funding is generally not considered for approval by the PENNVEST board until:

• An Act 537 Plan is approved (for sewer projects) or a feasibility study is approved (for water projects).
• Project design is complete.
• DEP permits are issued or the project is verbally approved by DEP.
• Technical evaluation and priority rating of application by a DEP representative is concluded

PENNVEST applies prescribed health, safety and environmental criteria in determining funding priority. A maximum of $11 million per project for a single municipality is available, and grant funding authorized by statute is limited to $250,000 for sewer projects.

The application process is very streamlined, and administration is fairly easy compared to other federal or state agencies. Local or project counsel is required to render enforceability and rate opinions and obtain approval of the Department of Community and Economic Development for municipal guaranty. Construction cannot commence until funding is approved and a written consent to proceed ("Letter of No Prejudice") is received from PENNVEST. Monthly progress reports must be submitted to PENNVEST during the construction period.

Authorities who opt to finance their projects with PENNVEST funds will enjoy many advantages of the program:

• It offers the lowest interest rates available.
• It may accept subordinate or party lien position in order to accommodate outstanding debt.
• The issuance costs are low.
• There is no negative arbitrage.
• A trustee is not required.
• However, there are also disadvantages to consider, as well.
• The board meets only three times each year.
• Approval is uncertain.
• It's sometimes difficult to coordinate project and financing timetables.

Undertaking design without a commitment for permanent financing is risky because PENNVEST may provide only partial funding and coordinating two financing agreements simultaneously is a complex process.

Although PENNVEST offers an advance funding program for especially needy communities, such loans are difficult to obtain, and no grants are offered through this program. Interim financing may be necessary to speed up the project and meet DEP commitments. Other disadvantages of this approach include the fact that borrowing may be limited to a term of no more than five years and must have a short call feature to allow current refunding with PENNVEST loan proceeds. Also, sewer projects funded by PENNVEST will lose Act 339 annual operating grant eligibility.

If federal funds are used, then Federal requirements under Title II and Title VI of Water Quality Act apply to project (Davis-Bacon Act, etc.).

Rural Utility Service (RUS)- U.S. Department of Agriculture
(Formerly Farmer's Home Administration - FmHA)
RUS provides long-term fixed rate financing (40 years) for qualified municipal utility projects. Eligibility is based on the reasonableness of estimated user charges and the median household income (MHI) of the municipality's residents. Grant funding also available if qualified and necessary to make the project affordable. The availability of loan and grant funds is determined in the federal budget, and competition among applicants in Pennsylvania is strong.

RUS loans offer a low interest rate – of just 5 percent for low income municipalities or an equally advantage rate for others based on average municipal bond rates and the longest fixed rate term available: 40 years. This will generally, but not always, result in the lowest annual debt service payments available. Overall, grant eligibility is up to 75 percent, but no grants are awarded until the minimum target user fee is reached and the actual loan and grant eligibility is determined by reasonableness of estimated user charges and MHI. A municipal guaranty may not be required, and issuance costs are generally low. RUS will provide commitment for permanent financing prior to authorizing design, but interest rate and grants are not established until time of settlement. A trustee is not required.

RUS's project involvement from funding through design and construction can add significant delays to project progress. RUS must approve the project scope, bid specifications, costs, etc. Interim construction financing is generally required but may be waived in certain cases. Future borrowing and expansion are subject to RUS approval and so are rate adjustments. A reserve fund equal to the annual debt service must be built-up over 10 years, and the possibility of a future loan call exists if the financial condition of the authority improves.

Public Bond Issue
Public bond issues are perhaps the most traditional method of funding for infrastructure projects in Pennsylvania . Municipal authorities can borrow at tax exempt interest rates for purely public projects for up to 30 or 35 years, depending upon the size and credit worthiness of the authority, the size of the issue, and the general economic conditions at the time of issuance. Interest rates may be fixed or variable, and security is generally the pledge of the system revenues. A municipal guarantee may be required under some circumstances. Bond insurance is often used to achieve a lower interest rate. A debt service reserve fund equal to 100 percent of the average annual debt service is usually required, but special circumstances may prevent its establishment. The services of a bond counsel are critical to the transaction. A trustee is also required, which is typically a bank having corporate trust powers or a trust company.

The bond market may be accessed in a number of ways but the two principle methods are 1) direct issuance by the authority utilizing the services of a bond underwriting firm or 2) the authority's participation in a bond pool.

The first method requires an authority to select an underwriter and sometimes a financial advisor to structure the bond issue and sell the bonds. The underwriter, financial advisor, bond counsel, authority solicitor, and engineer will structure financing specifically tailored to the authority's needs. The financing plan will take into consideration the authority's cash flow and revenue stream, length of the construction period, any existing indebtedness, and the need for future borrowing. Typically, revenue bond financing can be accomplished in a relatively short period of time compared to financings through state or federal agencies, and there is generally no third party review of the project scope, plans or specifications. Revenue bonds provide the most flexible financing option available to municipality authorities.

Generally, there are higher costs associated with the issuance of revenue bonds. The project team will consist of a bond underwriter, a bond counsel, and the services of a trustee bank or trust company. An independent financial advisor may also be retained, and additional work by both the authority's solicitor and consulting engineer is generally necessary. However, these latter costs may not be any greater than those that might be incurred in satisfying the state or federal requirements associated with financing provided through a governmental program. The need to establish and fund a debt service reserve account will also generate some additional costs; however, these funds may be invested, so the additional cost should be minimal when viewed over the life of the bond issue.

The second method by which municipal authorities can access the public finance market is through a bond pool. Bond pools, like the one established by the Pennsylvania Local Government Investment Trust (PLGIT) issue large amounts of debt for the purpose of lending the proceeds to eligible borrowers. Bonds are generally issued by a tax exempt body such as the Emmaus General Authority which issued the bonds for the PLGIT program. Other bond pools are available in Pennsylvania , but participation may be limited to specific types of borrowers or for specific purposes.

Generally bond pools will help lower the cost of issuance. Typically, they provide standardized documents to help reduce the legal cost associated with a bond issue, and there is no need for the authority to retain a bond underwriter. The authority may or may not choose to retain a financial advisor, depending upon the complexity of the transaction. There is usually no need to fund a debt service reserve account.

Not all potential borrowers are eligible to borrow from a particular bond pool. In addition, each participant in the pool must meet the minimum credit standards for the pool. Often, bond pools will offer only variable rates—although some pools provide an option for both fixed and variable. Bond insurance may be required. A portion of the loan proceeds may be used to currently refund outstanding debt, but advance refunding is generally not permitted.

Although bond pools offer attractive interest rates and typically lower costs of issuance, they may not serve the needs of all authorities or be advantageous for all projects. They deserve to be evaluated like all other financing alternatives available to authorities, but should not be pursued to the exclusion of other available options.

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