P3 Financing Options
Debt Financing Options
The private sector party in the P3 can lower the cost of capital spread between public and private finance with a number of debt financing options. Tax-exempt private activity bonds are the best option, as they equalize cost of capital with public sector tax-exempt financing. Under the Internal Revenue Code, government entities can issue tax-exempt debt (interest payments to debt holders are not part of gross income on which they are taxed by the IRS) to finance public infrastructure projects. Certain private sector infrastructure debt financing instruments, referred to as “qualified private activity bonds”, are also tax-exempt. Internal Revenue Service Publication 4078 provides a good overview of the Federal Tax Code tests and standards that must be applied to determine whether private sector participants can qualify for private activity bond tax-exempt treatment, including the various tests and standards that must be met to qualify (e.g. private business test, private loan financing test). Note that these requirements can place significant restrictions on how constructed infrastructure can be used. Congress limits the amount of qualified private activity bonds that can be issued for certain types of infrastructure projects by a state, using state annual volume caps, which states then allocate among qualifying private applicants seeking to issue these bonds.
The following chart lists the types of infrastructure facilities that qualify for private activity bond financing and whether they require a volume cap allocation:
Generally, the cost of capital for private activity bonds is on average higher than for government tax-exempt bonds, but in a much narrower spread (e.g., 100 to 300 basis points depending on whether such bonds are backed by availability fees or are subject to demand risk) than from taxable bond interest rates.
Other private activity debt financing options include two financing programs enacted by Congress: the Transportation Infrastructure Finance and Innovation Act (TIFIA) for transportation infrastructure (e.g., highways, bridges, rail, buses, intermodal connectors), and the Water Infrastructure Finance and Innovation Act (WIFIA), which was reauthorized in 2017, for water infrastructure (e.g., projects eligible for Clean Water State Revolving Loan Fund SRF financing [wastewater, reuse and stormwater projects] and Drinking Water SRF financing, as well as desalination, alternative water supply and aquifer recharge projects).
Each of the programs has a maximum funding percentage cap (up to 49%) and maximum debt repayment maturity limits (35 years), requires a dedicated source of revenue and creditworthiness, and provides below-market interest rates (generally U.S. Treasury rates for similar maturities). (See TIFIA Credit Program Overview, US Department of Transportation). Both of these funding programs require filing applications with the lead agency, followed by a vetting program and discretionary selection by the agency with individualized terms and conditions. Notably, both funding programs require the applicant to agree to applicable federal requirements (e.g., Civil Rights, NEPA, Uniform Relocation, Buy America, The Davis-Bacon and Related Acts labor and wage standards). The cost of complying with these federal requirements can offset the interest rate cost savings from participation in the funding programs.
Often, however, a major benefit of accessing the TIFIA and WIFIA financing programs is less the cost of capital savings, but the availability of program financing to bridge any gap in private sector funding availability. The TIFIA and WIFIA gap funding can represent the difference between a project moving forward or stalling for lack of full funding.