WASHINGTON -- A blue-ribbon panel in Maryland is considering creation of a natural resources district with authority to issue tax-exempt bonds and levy taxes to finance Chesapeake Bay restoration and improvement projects.

The financing option is expected to be discussed in a forthcoming report by the 25-member commission, which was appointed by Gov. William Donald Schaefer last spring to identify new ways of financing an ongoing bay cleanup.

The district could be modeled after a conservation district set up in Nebraska, according to Cecily Majerus, the governor's Chespeake Bay coordinator. But the district would be only one option on a planned menu of financing alternatives, and "there are many problems" with the idea, she said.

For example, the district would require cooperation among existing authorities overseeing watersheds in Maryland that include counties or "pieces of counties," which could raise political problems, Majerus said.

While a new district would be a state initiative, Maryland is part of a regional effort to clean up the bay, she said. A 1983 agreement among Maryland, Pennsylvania, Virginia, the District of Columbia, the Environmental Protection Agency, and the regional Chesapeake Bay Commission calls for work on the bay's tributaries to improve water quality in the main bay stem.

Maryland divided its part of the bay watershed into 10 sub-basins, with each jurisdiction developing a tributary strategy to reduce the total flow of phosphorus and nitrogen into the bay by 40%.

The state now spends about $176 million a year on its tributary strategy, but it falls $96 million a year short of what is necessary to carry out the program, Majerus estimated. The spending covers various practices such as sewage treatment, biological nutrient removal, and storm water management, she said.

The commission is expected to issue its report by late October or November. State and local and private sector entities involved in the tributary strategies would use the financial options to work out their own solutions under the voluntary program, Majerus said.

The demand for financing of environmental projects such as the Chesapeake Bay cleanup program far outstrips the allowed volume of tax-exempt private-activity bonds and federal grant funding, municipal market participants said last week at a mid-Atlantic conference on environmental finance in College Park, Md. The meeting was sponsored by the University of Maryland's Environmental Finance Center.

Financing specialists urged communities at the meeting to consider use of bond banks, structured municipal bonds, grant-backed credit enhancement, and public-private partnerships to help finance water and sewer and other environmental projects.

Michael Curley, a member of the Chesapeake Bay commission and a partner with Hall, Curley & Co., a private merchant bank focusing on infrastructure projects, advocated use of bond banks to improve small communities' access to the municipal bond market.

Curley, who also is a member of the independent Environmental Financial Advisory Board that advises the EPA administrator, said only about 5,000 of 60,000 water systems in the country have investment grade ratings. The cause is "structural," meaning the rating agencies "have developed a template which have now become matters of theology which don't fit 90% of the universe," he said.

Because of their relatively small capital needs and poor ratings, these communities have limited market access and get saddled with high interest rates and poor terms when they borrow, Curley said.

The advisory board has long urged creation of bond banks by states to pool credits and maintain a debt service reserve for small entities, but a major obstacle lies with outdated state constitutional provisions that prohibit municipalities from giving or loaning credit to other municipalities, Curley said.

While these provisions can be circumvented in some cases, bond banks are a form of structured finance that "needs policymakers at the state and local level to push the concept through," he said.

Other tools that can be used by small entities include use of structured municipal bonds that differentiate among cash flows to bondholders and thus result in lower blended interest rates, and use of anticipated grant money to leverage financing and secure credit enhancement, said Scott Reznick, founder of Commonwealth Development Associates, which develops infrastructure financing tools.

Use of these tools can save issuers 50 basis points on financings and lead to credit upgrades, he said. Reznick currently is analyzing the flow of Transportation Department grants to state and local governments and how the funds might be used for credit enhancement to support long-term financings. Reznick said he expects to submit a report soon to the Federal Highway Administration.

Privatization and public-private partnerships can provide economies of scale and flexibility in labor deployment, but much of what happens in this area will depend on federal infrastructure policy, said David Seader, a senior manager with Price Waterhouse and managing director of the Privatization Council Inc., a nonprofit educational group.

The Tax Reform Act of 1986 put a damper on many of the tax incentives for private sector involvement in public projects, Seader said.

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