Hunt Valley, MD

Financing Watershed Protection

Financing Watershed Protection

under the

Clean Water Act

            The Clean Water State Revolving Fund (CWSRF) was created by Congress in its 1987 amendments to the Clean Water Act. It replaced the $70+ billion construction grants program for Publically Owned (wastewater) Treatment Works (POTWs) that had been created in 1972. The authorizations for funding under the CWSRF, however, went far beyond POTWs. In specific, the CWSRFs were now permitted to fund both point-source pollution control projects as well as non-point source projects. To date, over 96% of the financial assistance made available through the CWSRF has gone to POTWS. But that is changing. For example, it is estimated that now 60% of the pollution in the Chesapeake Bay comes not from POTWs, but rather from agricultural runoff. So the focus is shifting to non-point sources of pollution.

Among the non-point source projects eligible for funding under the CWSRF are watershed protection projects. For example, this is how the State of Illinois describes its program: “The program includes providing funding to these groups to implement projects that utilize cost-effective best management practices (BMPs) on a watershed scale. Projects may include structural BMPs such as detention basins and filter strips, non-structural BMPs such as construction erosion control ordinances and setback zones to protect community water supply wells. Technical assistance and information/education programs are also eligible.”

The 1987 amendments required states to set up, or designate, agencies to manage funds, which were appropriated by Congress and passed through the USEPA. So there are now 51 CWSRFs, one in each state plus Puerto Rico. These appropriations go to the states as grants. But that is as far as the grants go. The states are prohibited from making grants with this money. Instead they must lend it; it must be repaid; then they must lend it again. In short, the money must “revolve.” The 1987 amendments also set up eligibility categories and procedures for these state-managed loan funds.

Section 319 and intended use plans            Section 319 of the Clean Water Act addresses non-point source pollution. This section requires the states to inventory their receiving waters and identify those water bodies that are impaired by non-point source pollution. The states are then required to prepare what is known as a “319 Program,” which describes how the state will deal with these non-point sources of pollution. These 319 Programs are sent to EPA for approval.

Protecting watershed is an eligible activity under section 319. And in order to finance such projects, this activity should be spelled out in each state’s 319 Program. That’s step one in getting CWSRF help.

Title VI of the Clean Water Act sets forth the provisions of the Clean Water State Revolving Fund. As might be expected, there are eligibility categories as well as procedures for this program too.

Title VI requires states to create Intended Use Plans (IUPs) that set forth the types of projects the CWSRF intends to spend its funds on. Each year each state must prepare a draft IUP, put it out for public comment, and submit it to EPA. Once the IUP is approved, the states then solicit applications for funding. Getting watershed protection into the CWSRF’s IUP is step two in getting its financial assistance.

Climbing the project priority list

Title VI also requires states to prepare Project Priority Lists (PPLs), which actually list the projects to be funded in the order in which they will be funded, and in the amount in which they will be funded. States have a finite amount of money to lend, so, in times of strong demand, there is an imaginary line on each PPL. If your project is above the line it gets funded, if you are below the line it doesn’t get funded unless a project with a higher priority is canceled or postponed and your project moves up the list to where it is above the “line.”

So, how, in general, do watershed protection projects stack up in the prioritization game? Answer, not well. A POTW that cleans X gallons of water a day and is going from secondary to tertiary treatment will remove Y pounds of nitrogen, for sure. How much nitrogen will be prevented from entering receiving waters if an acre of forest is preserved rather than turned into farmland or a housing development with large over-fertilized lawns? Who knows? At least that’s the way most of the engineers look at these matters. Although our understanding of how natural infrastructure filters nutrients and other substances in water is constantly improving, we have a ways to go with regard to measuring impacts. It is, therefore, no wonder that the CWSRFs have spent 96% of their funds on POTWs.

Guaranteeing results

Despite the challenge of quantifying their filtering benefits, source water protection programs offer many benefits to the water community. How then can watershed protection projects navigate the political/prioritization thicket of the CWSRFs and get funded? The answer is to seek a loan guaranty from the CWSRF, not a direct loan. DEFINE A LOAN GUARANTEE AND HOW IT WOULD LOOK DIFFERENT FROM A DIRECT LOAN.

This is step three in the CWSRF financing procedure.

To begin, there should a new first line for Title VI printed in foot-high red letters. It should read: THIS IS A SUBSIDIZED DIRECT LOAN PROGRAM.

Title VI of the Clean Water Act authorizes both direct loans and loan guaranties. Of the over 30,000 projects that the CWSRFs have funded since 1987, fewer than a dozen have involved the loan guaranty authority. The reason for this is that the direct loans are made at subsidized interest rates, which all of the local POTWs want.

In general, subsidized CWSRF loans are made at rates that are about 50% of market rates. In today’s world, that’s about 2%. Vermont makes 0% loans. This is the money that is subject to the often fierce competition on the PPLs. Meanwhile, projects seldom seek guaranties.

Does using the guaranty authority in any way limit the amount of subsidized loans that a state can make? Functionally, no.

How much more is available?

The net assets of the CWSRFs can be used as a short-hand measure of their guaranty capacity, in much the same way that the common stock of a bank can be used to measure its capacity for making loans. If a bank has $10 billion of stock, you should expect to see its loan portfolio in the $80-120 billion range. In short, the ratio of loans to stock is 8-12:1. In this regard, the combined net assets of the CWSRFs is over $40 billion. However, according to Standard & Poor’s (S&P) and the other international credit rating agencies, wastewater loans are much safer than the commercial and consumer loans that banks make. So, in this case you would expect to see 25+:1 ratios of guaranties to net assets. (S&P says 75:1.) But at a ratio of only 25:1, the combined CWSRFs have $1+ trillion of guaranty capacity. At present, the total leverage ratio of all the CWSRFs is a little over 2:1, which means outstanding direct loans in the $80-100 billion range. Thus the combined CWSRFs have well over $900 billion of unused financial capacity. In short, the CWSRFs cannot make an infinite amount of guaranties, but their unused financial capacity is so great, that there is no real functional limit.

So, the CWSRF can be used to guaranty bonds issued by local governments or even not-for-profit corporations for watershed protection projects.

Satisfying the CWSRF’s rules

Regardless, however, of whether a project takes advantage of a direct loan or a guaranty from a CWSRF, it must obey the other CWSRF rules. Most of these rules pose no difficulty for typical watershed protection projects. That said, most watershed protection projects are paid for with grants or donations – money that does not need to be repaid. CWSRF money, whether as loans or guaranties, needs to be repaid. Furthermore, one of the CWSRF rules requires a “dedicated revenue stream” for repayment.

A “dedicated revenue stream” has two characteristics. It must be reliable. And it must, of course, be dedicated.

By “reliable,” bond lawyers are thinking sewer fees and charges that system users pay every month, quarter, or year. Taxes and other fees can be used as well. But these fees and charges cannot be voluntary and they cannot fluctuate to any significant degree. This means that conservation NGOs and other such organizations cannot use their dues revenue to meet the “dedicated revenue stream” test. Such organizations can, however, use endowment income to meet the test. This can be tricky. If the endowment has earned at least $10 million a year for the last 10 years, and it only needs $1 million to pledge against a CWSRF-guarantied bond, the bond lawyers and rating agencies would probably let an organization get away with it as long as it pledges the “first $1 million of earnings” from the endowment. Likewise, segregating specific, highly-rated, fixed-income securities and pledging their interest earnings would also work. So, it can be tricky, indeed; but it can be done.

The final caveat, of course, is that these revenues must be “dedicated.” This dedication must be formal. It can be done by a local law or ordinance, in the case of a local government. Where businesses, NGOs or individuals are concerned, such pledges can be secured by contract. But a bond counsel’s opinion will be needed on the contract.

Another promising source of dedicated revenue that could play a big role in loan guarantees for watershed protection are the source water or watershed protection fees and other financial structures being used in dozens of communities across the Country. Raleigh, North Carolina, for example, charges its 600,000 system users $0.0748 per hundred cubic feet. This volumetric rate generates about $1.3 million annually that is dedicated for watershed protection activities. This is a good boost to source water protection efforts, but imagine what could be accomplished if this dedicated revenue was used as a loan guaranty—it could generate almost $20 million that could be used to implement projects at today’s prices.

Organizing a “dedicated revenue stream” is the fourth and final step in the CWSRF financing process.

So, in summary, the CWSRF can definitely be used to finance watershed protection projects. And with $1 trillion of financial capacity, it should definitely be used to do so.

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