December 12, 2016
By: Seth Brown, Founder of Storm and Stream Solutions, and THG Senior Advisor for Stormwater/Green Infrastructure, Public-Private Partnerships, & Economics
Developing the Motivation to Invest in Green Stormwater Infrastructure
A common complaint heard from municipalities regarding needed wet weather investments is that regulations are requiring them to implement more stormwater infrastructure than they can afford. The premise of this complaint is that: a) stormwater runoff is a burden, and b) investments in stormwater infrastructure are only (or at least primarily) driven by regulations. These views reflect a mindset that is inherently self-limiting and non-aspirational. In other words, community leaders with this vision (or lack thereof) create a self-fulfilling prophecy that reinforces these negative views regarding funding and financing for stormwater infrastructure. But there is another way to consider these investments.
To contrast with the negative view, communities would benefit by widening their consideration for the potential investment in stormwater infrastructure (specifically, green stormwater infrastructure, or GSI) beyond regulatory compliance but to account for other aspects, such as the numerous social benefits achieved through economic redevelopment, “green” job creation, enhanced community resilience, increased property values, and improved public health and safety.
In this way, communities will start to view GSI as an opportunity not a burden. Once this shift in mindset has been made, communities will see that investments in stormwater management go beyond regulations as well. And after community leaders see GSI as an opportunity in the broader context and understand that investments in this infrastructure type can go beyond (as well as complement) regulatory requirements, there will be a greater sense of urgency to find paths to invest in GSI as opposed to reasons why it cannot be done.
A recent article from Bloomberg BNA, co-authored by one of U.S. EPA’s GSI champions, Dominique Lueckenhoff, provides hope to communities who are motivated to make large-scale investments in GSI as numerous funding and financing options are available to communities and that these options need not come with a high price tag.
What Are the Possible Funding/Financing Vehicles for GSI Investment?
Thankfully, there are many ways that GSI can be funded and financed, as the BNA article points out. The most common form of stormwater funding is through general funds at the local government level, although there are several other or additional alternatives, such as in-lieu and permitting fees or grant programs. However, these funding sources, while common, limit overall GSI investment potential since they are not consistently funded nor are they dedicated to stormwater program investments.
Other infrastructure sectors, such as drinking water and wastewater sectors, can issue bonds for large-scale infrastructure investment through dedicating rate payer fees as securitization. Communities who have not created a dedicated funding stream for stormwater management are limited and cannot expand overall investments through the capital markets. This fact may compel some communities to consider the development of a stormwater utility, which can provide this dedicated and equitable revenue stream and open the door to large-scale GSI investments by providing a securitization for various financing options.
Public financing options are also available for GSI investment, and the first stop for communities when exploring these options should be the Clean Water State Revolving Fund (SRF). This program, which started out in the 1970’s as the “Construction Grants Program” and provided billions in needed infrastructure investment during the first 15 years of the Clean Water Act’s implementation, provides below-market financing to communities who want to invest in capital projects in the Clean Water sector. Historically, this program has focused on the wastewater sector, as is reflected by the fact that approximately 95% of these investments in EPA Region 3 (Mid-Atlantic) have gone strictly for wastewater infrastructure, and other regions reflect similar rates of investments. Considering that urban stormwater runoff and nonpoint pollution have become the water quality issue of the 21st century, this percentage must start to change. EPA has sensed this urgency to shift SRF focus more towards urban runoff, which is evident by the push made by the Agency in recent years to focus more on urban stormwater in the SRF context.
The SRF is now being considered as not just a grant or loan program, but it is being viewed as another way to expand GSI investment by lowering financing costs through securitization of municipal bonds as well as facilitating the leveraging of financing packages. In these ways, as the article points out, significant financing cost savings can be realized. For example, a community with an “Aa” rating can use SRF assistance as bond insurance to increase the bond rating to “Aaa”, which results in an interest rate reduction of 50 basis points (0.50%) that will further reduce the financing costs for a 30-year term, $50 million dollar investment by $5 million, or 10%. When viewing at a macro scale, it is estimated that GSI investments can be expanded up to $6 to $28 billion across the country (as estimated by the EPA Environmental Finance Advisory Board) through the use of SRF assistance as a guarantee.
The other significant public financing option is the municipal bond market, which drives most infrastructure investment across the country – but not so much in the stormwater sector (due to the aforementioned lack of dedicated funding). As needs change, however, so will financing decisions, especially when other innovations are revealed in the sector, such as the use of SRF assistance to enhance the attractiveness of capital market investments.
The options for private financing includes bank loans, private equity, and a new and emerging field of “socially responsible financing”. Each of these options have a role to play in financing GSI investments. For instance, bank loans provide good short-term “bridge” loans during times when other financing has not been established. Private equity is not often used, but it can play a critical role in the context of developing cutting edge technologies, which may be able to enhance performance and drive down costs for GSI in the future.
The “hottest” form of private financing these days is “socially responsible financing”, which include “green bonds” and “social impact bonds”. Green bonds, which is a bond that, “can be used to finance projects that are environmentally beneficial, such as climate adaptation, pollution prevention or water quality projects,” according to an October, 2016 report on green bonds in the market. These financial products have been on the rise over the last handful of years, but slowed in 2016, most likely in part due to issuers may be wary of added costs to certify a bond as being “green” while adding no/little additional value to the issuance. Another type of socially-driven private investments is through an instrument known as a social impact bond (SIB). These products are a misnomer, as they are not bonds in the traditional sense. They are normally used in the context of a “Pay-For-Success” (PFS) program, which uses funds from “impact investors” to finance projects that provide a payout to investors that is scaled based on the amount of “success” (however that is defined) in meeting project objectives. A driver for the PFS model is that of a (growing) segment of private investors who are seeking to not only receive a return on investments, but also want to be ensured that their investments are leading to measurable social or environmental improvements.
While the PFS model is based upon a solid premise – only pay for what works – it is sometimes the case that focusing only on measurable aspects of programs may diminish the ability to succeed, especially if more holistic and non-easily-measured factors are more effective overall in achieving “success” or if there are not easily measured aspects to focus on. A recent article in Nonprofit Quarterly stated that – in the context of PFS projects – there have been “no true success stories”, and that, “PFS interventions don’t recognize that fixing complex social programs typically requires investments and policy changes on multiple levels.” In other words, PFS is a not a “silver bullet” solution that focuses on one specific way to solve a social or environmental problem. The PFS model is most commonly associated with social issues, such as reducing homelessness or asthma rates. The only water-focused PFS was just recently established by DC Water that raised $25 million to retrofit 20 acres of impervious cover using GSI practices. It should be noted that the unit cost associated with this program, $1.25 million per impervious acre treated, is much higher than the unit cost associated with traditional GSI project implementation, which can range from $150,000 to $250,000 per impervious acre treated. The implication of this cost differential may signal to the sector that large-scale investments in GSI using the PFS model may be challenging. The relatively high unit cost for GSI associated with the PFS approach also may confuse some in the sector, which may lead to hesitation when considering GSI as an alternative to other approaches. It will be interesting to see how this PFS program performs overall, as well as the level of transferability of this model.
With many options available for funding and financing for GSI investments, it may be hard to decide on just one – but that would be missing the point. Like a good Swiss Army knife, a financing approach that includes a variety of tools allows a community to arm themselves with the ability to generate the best deal for their money. A “blended finance” approach simply utilizes the strengths of certain types of financing, such as bank loans for bridging purposes or SRF loans and credit enhancers to provide a below-market rate of return, to develop an overall financing package that meets the needs of the program while not burdening the community with high-rate financing.
Putting it All Together
Financing is only one piece of the puzzle for GSI implementation. In order to make the most of funding and financing in a program, GSI practices should be designed, constructed and maintained as efficiently as possible. The Community-Based Public-Private Partnership (CBP3) program approach provides this ability to deliver projects in a cost-effective manner by using integrated services (design-build-maintain), capturing economies of scale through large-scale implementation efforts, and a streamlined procurement process. The CBP3 program also provides a platform for blended financing, which is often missing in stormwater programs, and in this way, can leverage a dedicated funding source (e.g. stormwater fee) to generate significant GSI investments. An example of how this can all come together for a community is to consider a community with 1,665 acres of imperviousness who wants or needs to retrofit 20% of this area using GSI practices. Assuming this community has a stormwater utility that generates $2.5 million annually, the 333 acres of retrofitting can be successfully achieved by developing a financing package with a blended rate of 3.5% to deliver $10 million dollars of investment per year over a 5-year permit.
As they say, “where there’s a will, there’s a way.” In the context of large-scale GSI implementation, this adage can be changed to, “where there’s a will (to green), there’s a way (to pay for it)”. Yes, funding challenges are real in the stormwater sector – there is no doubt of that, but two things are clear: (1) there are new and innovative ways to finance GSI, and (2), the many benefits provided by GSI make this infrastructure one that can attract financing. Whether the drivers are job creation and economic development or regulatory compliance, the deployment of large-scale GSI is being increasingly viewed as a strong alternative – and now the ability to fund/finance and deliver GSI projects efficiently in order to provide large-scale implementation has been realized. In this way both the “will” and the “way” can be aligned for the benefit communities around the country.
Seth Brown is the Principal and Founder of Storm and Stream Solutions, LLC, a consulting firm providing a range of services from policy and infrastructure finance analysis in the water sector to the development and delivery of technical and policy-related training focused on topics such as stormwater and public-private partnership arrangements.