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