Explaining RCA's Letter on Metro Funding, Colin Mills, RCA President, Reston Patch, July 11, 2012

As you know if you're a regular Patch reader, yesterday I issued a letter to Governor McDonnell on the issue of Virginia's planned funding for Phase 2 of the Silver Line, and how it could best be applied. This may not be the easiest issue to understand, so I wanted to use this week's blog to explain RCA's position -- and why it matters how the state funds are spent.

It's definitely good news for the Silver Line and for the users of the Toll Road that the Commonwealth and MWAA were able to resolve their stand-off over the Project Labor Agreement.  MWAA agreed to drop its preferential treatment of PLAs in the bidding process, and the McDonnell administration agreed to provide the $150 million it had promised for Phase 2.  Although the $150 million is a small fraction of the overall cost of Phase 2, it's certainly better than nothing, and RCA is glad that the Commonwealth will be helping to finance the construction of Phase 2.

Our concern has to do with the way in which the state funds are applied.  RCA is proposing that the $150 million be used to buy down the capital costs of construction, rather than paying the interests on MWAA-issued revenue bonds used to finance the construction.  We believe that buying down capital provides Virginia and the project with much more bang for the buck.

At first glance, it may be hard to understand why we're making a big deal out of this.  After all, $150 million is $150 million no matter where it's spent, right?  In the end, shouldn't it all come off the bottom line the same?  Actually, no.  In order to understand why, let me use an analogy: buying a house.

Let's imagine that you've bought a house that cost, say, $300,000.  Unless you're fortunate enough to have that kind of cash on hand, you're going to finance your purchase by taking out a mortgage.  This allows you to pay off the cost of the house over 20 or 30 years, rather than needing to have the money upfront.

Of course, this comes at a cost.  Over the course of your mortgage, you're going to pay a lot more than $300,000, because of the interest.  When the bank loans you the money to buy your house, they demand a certain level of return to make it worth their while.  If you take out a 30-year mortgage at an interest rate of 5%, for example, you'll wind up paying about $575,000 over the life of the mortgage -- almost double the original cost.  As you can see, interest represents a significant cost when financing big-ticket items over an extended period of time.

MWAA faces the same situation when it comes to the Silver Line.  They don't have $3 billion on hand to pay for the project upfront, so they'll need issue revenue bonds (the equivalent of your home mortgage).  Depending on the interest yield they're able to get for the bonds, the overall financing cost for the Phase 2 could be as much as $15 billion.  Obviously, anything that can be done to deduce the finance cost of the project would be a boon.

Now, let's return to our analogy so I can explain RCA's position.  Imagine that you have a friend who's willing to pay $10,000 toward the cost of your house.  Would you be better off if he gave you the $10,000 as a down payment on the house, or if he applied the $10,000 on your mortgage payments?  If you're smart, you'll take the down payment, because it reduces the amount of money you'll have to finance, thus bringing down your interest costs.  Over the life of a 30-year mortgage, a $10,000 down payment will save you about $40,000 in total payments.  Same amount of money, different results.

The same is true for the Silver Line.  If Virginia's $150 million were used to pay for the capital cost of construction, it reduces the amount of bonding MWAA must do to pay for the project.  Again, depending on the interest yield on the bonds when they're issued, using Virginia's funds to pay for capital would produce approximately 3 to 5 times the total savings compared to using the funds to pay interest on the bonds.  More bang for our state-funding buck!

At this point, you may be thinking: the Commonwealth and MWAA surely have plenty of smart people who understand how finance works, so why would they even consider using the money for interest instead of capital?  The answer: The short-term toll rates.

As we all know, MWAA will be paying for its share of the project by raising tolls on the Dulles Toll Road.  How much those toll rates will need to rise obviously matters to everyone involved, but how fast they go up might matter just as much to some, especially for elected officials who might suffer near-term punishment at the voting booth if the tolls spike quickly.
If the state funds are used to pay the interest on MWAA's bonds, it allows MWAA to delay the proposed toll increases in the short term.  (Returning once more to our house analogy: If you used your friend's $10,000 to pay your mortgage instead of making a down payment, your total expenses in the first year of your mortgage would be lower, because your friend is paying most of the freight that year.)  Otherwise, MWAA contends, the only way they could reduce the short-term toll increases would be to issue a different type of bond that would require a higher yield.

But is it worth it to delay the pain of toll increases for a couple of years if it costs us more over the life of the project?  Short-term thinking has wreaked a lot of havoc in our economy in recent years.  We're going to be paying for Phase 2 for decades, so let's spend our money wisely.  I hope that MWAA and the Commonwealth will do the right thing, and make the smartest decision for the long term.

I want to thank RCA's research wizard, Terry Maynard, for being the first to point out this concern and for crunching the numbers that went into my letter.  Terry and RCA's Reston 2020 Committee are still working hard and remaining vigilant to ensure that the Silver Line brings greater benefits and fewer costs to the citizens of Reston.