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Improving Water Infrastructure by Securitizing Rate Payments
Nihal Jambotkar &Chris Canazaro
Background
The US needs to invest $334.8 Billion in Drinking Water Infrastructure by 2026
An additional $322 Billion in Wastewater Infrastructure by 2030
Current infrastructure is inefficient and results in the loss of water resources
Water Rate History
Water Rates increased by 9% on average last year.
Water rates have increased by 2x CPI over the last 30 years
No investment vehicle is currently available to invest in water resources
SolutionSecuritize Water Rate Payments into an Asset-Backed Security
Offer Investors an Inflation-Adjusted Fixed Income Vehicle
Reduce the Cost of Financing for Municipalities
Provide the Basis for Increased Knowledge of Efficient Water Pricing
Why an ABS?Convert illiquid assets into financial instruments that can be bought and sold freely
Provide cheaper financing for entities due to a higher credit rating by decoupling borrowing costs from Municipal Credit Ratings
Facilitates marketing of securities to investors with different risk appetites and investing time horizons
ImpactPrice Discovery
Mechanism for Water
• Incentivize more effective usage and pricing by stakeholders
• Promote water conservation efforts
Funds Infrastructure Investment
• Upgrading infrastructure will increase resource efficiency through reduction in use and loss of water in the system
Financial BenefitsInflation Hedge
• Currently – Best Inflation Indexed Security is US-TIP
• ABS offers an inflation protected return higher than US-TIP
Funding Spread
• Provides cheaper funding for Municipalities than traditional GO & RV Muni-Bonds
Investment StructureFuture Rate Payments to Utility
Packaged as a 30 year lease between the Utility and Municipality
Lease Transferred to Special Purpose Entity
SPE Packages Lease as an Asset-Backed Security
ABS is Sold to Investors
ModelNPV of Payments to the Municipality & Investors
Inflation-Adjusted Return to Investors
Calculated Spread for Municipality Cash Flows
Goal: Provide Higher Return Spread for the Municipality over Conventional Bonds
Goal: Provide Higher Return for Investors over Inflation-Adjusted Treasuries
Investor ReturnsPremium over Inflation Indexed Treasury Percentage Return on top of 3% Inflation
Adjustment
50 Bps 2.625%
75 Bps 2.875%
100 Bps 3.125%
150 Bps 3.625%
200 Bps 4.125%
Sensitivity AnalysisPremium over Inflation Indexed Treasury Percent Spread Over Municipal Bond
50 Bps 12.8%
75 Bps 10.9%
100 Bps 9.0%
150 Bps 5.2%
200 Bps 1.4%
Legal Status
In order to be competitive with municipal bonds this product will have to offer tax-free interest payments to investors.
Due to the unprecedented nature of this investment vehicle it can not be guaranteed at this point.
Product feasibility will require legal counsel and possibly result in litigation and regulatory hurdles prior to implementation.
Implementation
Partnering with industry will be the differentiating factor for success.
Having the technical ability to implement infrastructure projects will provide a competitive advantage over purely financial institutions.
Conclusion
The ABS approach represents a new option for infrastructure financing that will offer better than market rates of return for both issuers and investors.
Increased investment and price discovery will provide a positive impact for water use and conservation.
AssumptionsExpected Annualized Water Rate Growth (x2 Inflation) 6.000%Expected Inflation 3.000%Current Muni Yield 4.316%30-year Inflation Indexed Treasury + 100bps 3.125%30-year Treasury current yield 4.270%
Current Expected Cashflows (per customer)
time 0 1 2Cash Flow received by Municipality $100.00 $6.00 $6.36 Cash Flow received by Security Holder $- $4.32 $4.32 Difference (Spread) $100.00 $1.68 $2.04 PV of Spread (discounted at 30 year Treasury rate) $100.00 $1.62 $1.88 NPV of spread to Municipality $220.61
Repackaged as ABS (Inflation adjusted)time 0 1 2Cash Flow received by Municipality $100.00 $6.00 $6.36 PV Cash Flow received by Municipality (discounted at Treasury Rate) $100.00 $5.75 $5.85 Inflation Index 100.00 103.00 106.09Cash Flow received by Security Holder $- $3.22 $3.32
PV Cash Flow received by Security Holder (discounted at adjusted Treasury Rate) $- $3.00 $2.87 Difference (Spread) $100.00 $2.78 $3.04 PV of Spread $100.00 $2.76 $2.98 NPV of spread to Municipality $240.54