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Testimony given by The Honorable Joseph H. Boardman, Administrator

Chairman LaTourette, Ranking Member Brown and other members of the Subcommittee, it is my pleasure today to represent Secretary of Transportation Norman Y. Mineta to discuss the status of the Federal Railroad Administration's (FRA) implementation of the Railroad Rehabilitation and Improvement Financing (RRIF) Program.

The RRIF Program in Brief

The current RRIF program was created in 1998 in section 7203 of the Transportation Equity Act for the 21st Century (TEA-21). Section 7203 significantly amended the RRIF program created by Title V of the Railroad Revitalization and Regulatory Reform Act of 1976 but which had lain largely fallow due to changes in the requirements for Federal direct loan and loan guarantee programs created in the Credit Reform Act of 1990 and the lack of appropriations. To date, RRIF has been the primary discretionary program available to FRA to provide financial assistance for capital improvements to the rail industry.

One of the significant features of the Federal Credit Reform Act of 1990 was to require Federal agencies to set aside the estimated long-term cost of providing new credit assistance in the form of direct loans or loan guarantees. That cost reflects the net present value of the expected cash flows to and from the Federal Government over the life of the loan. Funds are obligated for subsidy cost at the time the direct loan or loan guarantee agreement is signed, with the cost estimate calculated using the assumptions used to formulate the President's Budget for that fiscal year, updated to reflect the terms of the loan contract. When viewed on a program basis, setting aside the estimated long-term cost helps avoid a potentially significant un-budgeted expense at the time of a default.

After enactment of the Federal Credit Reform Act and until the TEA-21 amendments, the only way that FRA could provide financial assistance through direct loans or loan guarantees was if the Congress appropriated funds to cover the subsidy cost. The Congress did once, in FY 1994, and earmarked funds for a specific loan guarantee. The major change resulting from the TEA-21 amendments was that the subsidy cost could be paid by the applicant or other non-Federal infrastructure partner, in the form of a "credit risk premium," and thus the ability of FRA to provide direct loans or loan guarantees was no longer dependent upon the receipt of an appropriation. In consideration of the credit risk premium requirement and the ability for it to be paid from non-Federal sources, the program is considered "zero-subsidy" in that the Federal Government does not have to provide appropriations for the initial subsidy cost. However, the Federal Government bears the risk of cost increases if RRIF loans perform worse than expected.

Under the RRIF program, the Secretary of Transportation (Secretary) (who has delegated responsibility for implementing the program to the Federal Railroad Administrator) provides financial assistance in the form of direct loans or loan guarantees to eligible recipients for the purpose of acquiring, improving, or rehabilitating intermodal or rail freight or passenger equipment or facilities, including track, components of track, bridges, yards, buildings or shops; to refinance outstanding debt incurred for these purposes; or to develop or establish new intermodal or rail facilities. Operating expenses are not eligible for financial assistance under the RRIF program. Eligible applicants are State and local governments; interstate compacts consented to by Congress under section 410(a) of the Amtrak Reform and Accountability Act of 1997; government sponsored authorities and corporations, railroads, joint ventures including at least one railroad and, solely for the purpose of constructing a rail connection between a plant or facility and a second carrier, and limited option freight shippers that own a plant or other facility that is served by no more than a single railroad. Direct loans can be made for up to 100% of the total project cost, for terms up to 25 years and at an interest rate equal to the cost of borrowing for a comparable term based on the current Treasury rate at the time of closing. Loan guarantees can be made for up to 80% of the cost of a loan, for terms up to 25 years, at a rate the Secretary determines reasonable taking into account prevailing interest rates and customary fees incurred under similar obligations in the private capital market.

Since the current RRIF program was created in 1998, FRA has entered into 13 financing agreements with 12 railroads in the total amount of $517.7 million. All of this financial assistance has been made through direct loans. Recipients have included one Class I railroad (Amtrak), two Class II railroads and nine Class III railroads. A list of these loan recipients is attached as Appendix 1 to this statement.

Of the amount of financial assistance provided to date, approximately 52 percent has been for infrastructure improvement, approximately 37 percent for railroad acquisition, approximately 4 percent for equipment acquisition and 7 percent for refinancing outstanding debt incurred for eligible purposes.

Steps in the RRIF loan process

There are nine major steps in the evolution of a RRIF loan:

* Preapplication Meetings: Potential RRIF applicants typically meet with FRA in advance to review the requirements for an application and the likely costs and terms of financial assistance. Many of the RRIF applicants have had little past experience with Federal funding programs, thus issues such as the time and cost associated with FRA's need to comply with the National Environmental Policy Act (NEPA), Section 4(f) of the Department of Transportation Act, and Section 106 of the National Historic Preservation Act may come as a surprise. So too, at times, is the rigor with which FRA will analyze the business case for the proposed financial assistance and the documentation that will be required for that analysis. Some railroads have chosen not to proceed with RRIF applications after the preapplication meetings.

* Applications: Parties interested in seeking financial assistance from FRA submit an application addressing the requirements of an application, as laid out in the regulations implementing the RRIF program (49 CFR 260) and augmented by preapplication meetings. FRA reviews the material submitted and identifies where additional material will be required to complete the application. At times this might be updating details of the applicant's recent financial performance or the basis for the applicant's projections of future growth in its traffic base, refinement of the cost estimates for improvements to be funded, or more information on the environment of the area where improvements are proposed.

* FRA's Analysis: FRA initiates its analysis of applications once sufficient information has been submitted, even though an application might not yet be complete in all respects. FRA undertakes an independent detailed review of the financial aspects of the proposed project including reviewing the railroad's past financial performance and the basis for estimating costs (both project and future operating and capital needs) and future revenues. Where appropriate, FRA reviews the project designs to assure that the project as proposed can reliably accommodate the volume of traffic needed for the railroad to achieve its revenue projections. As with all other Federal agencies, FRA's analysis also includes the reviews necessary to comply with NEPA and related environmental laws, regulations and orders, including where necessary, the preparation of an environmental impact statement.

While FRA's staff possesses broad technical expertise, conducting the level of analysis required for thorough review of multiple concurrent applications requires access to greater resources, some of which are very specialized. FRA has used two approaches to acquire the expertise necessary to supplement existing FRA staff in reviewing applications. Until the Safe, Accountable, Flexible, Efficient Transportation Equity Act: A Legacy for Users (SAFETEA-LU) (Public Law 109-59, August 10, 2005) was enacted, FRA required applicants to fund a "third party" contractor; that is, applicants paid for financial advisors who received technical direction from FRA to undertake independent reviews of portions of the application. More recently, FRA has used the opportunity provided in RRIF's modified statute to assess investigation charges of up to one half of one percent of the proposed financial assistance to fund contractors working directly for FRA to supplement FRA staff in the review of applications.

Upon completion of the analysis of the application by FRA staff and independent contractors where needed, FRA staff develops a draft recommendation as to how to proceed with the application, i.e., whether to recommend approval, rejection or rejection with suggestions of how a proposal might be amended and improved so that it could move forward at a later date. FRA staff also prepares a draft calculation of the required credit risk premium using methods approved by the Office of Management and Budget. A description of the FRA process for calculating the amount of the credit risk premium is attached as Appendix 2 to the statement.

* DOT Credit Council Review: The proposed direct loan or loan guarantee is presented to the DOT Credit Council. This Council is composed of nine members including: the Assistant Secretary for Budget and Programs who serves as the chair; the Under Secretary for Policy; the General Counsel; the Assistant Secretary for Transportation Policy; the Federal Highway Administrator; the Federal Transit Administrator; the Federal Railroad Administrator; the Maritime Administrator; and the Director of the Office of Small and Disadvantaged Business Utilization. The DOT Credit Council reviews the proposed transaction and makes a recommendation to the FRA Administrator about the project's financial viability and consistency with Departmental policies, including credit policies.

* Administrator's decision: The FRA staff recommendations and the Credit Council recommendations are presented to the FRA Administrator. As provided for by SAFETEA-LU, the amount of time that elapses between the completion of an application and a decision by the Administrator is 90 days or less.

* OMB Review: At the time the DOT Credit Council recommendations are submitted to the FRA Administrator, FRA's estimate of the required credit risk premium is submitted to the Office of Management and Budget (OMB) for review and concurrence, as is required under the Federal Credit Reform Act. Per its Federal Credit Reform Act responsibility for determining subsidy costs, OMB reviews and approves subsidy cost estimates for Federal credit programs.

* Financing Agreement: Assuming that the Administrator decides to provide the requested financial assistance, FRA notifies the applicant of FRA's offer of financial assistance, and the terms under which it will be provided (the interest rate and amount of the credit risk premium.) FRA and the applicant then finalize the terms of the financing agreement and all other necessary legal documents, such as mortgages to secure pledged collateral. Most of terms of the agreement are standard and are available to the applicant well in advance of this point. In addition to the standard terms, there may be project specific terms, such as a commitment of improved cash flow from refinancing of an existing debt to a capital improvement program or requirements imposed on the applicant to assure the protection of environmentally sensitive sites.

* Project Implementation: Once the agreement is signed, funding is made available to implement the project and is provided only as needed. This helps FRA assure that the project is undertaken in the most timely and cost effective manner possible. FRA staff with specific expertise, such as track engineers, may monitor the progress of specific major project elements to assure they are being implemented as planned and are progressing on schedule.

* Loan servicing: FRA staff monitors the repayment of the financial assistance and the continuing financial condition of applicants.

SAFETEA-LU Amendments
Section 9003 of SAFETEA-LU amended the RRIF program in a number of ways. It has now been seven months since enactment of SAFETEA-LU and I wish to report briefly on FRA's implementation of the most important of these amendments:

* Expansion of eligible applicants: SAFETEA-LU effectively expanded the types of entities eligible for the RRIF program to include limited option shippers and commuter railroads. While FRA has been contacted by several limited option shippers, to date none has filed an application. FRA has recently received, and is currently processing, a loan application from a commuter railroad to fund the acquisition of 50 new passenger cars.

* Expansion of the list of projects to be given priority consideration: SAFETEA-LU added to this list projects that "enhance service and capacity in the national rail system" and "would materially alleviate rail capacity problems which degrade the provision of service to shippers and would fulfill a need in the national transportation system." Without commenting on any application either pending or that might be filed in the future, I would note that these two types of projects can be viewed as addressing congestion on nationally important rail lines.

* Expanding RRIF assistance levels: SAFETEA-LU expanded the total authority for outstanding RRIF financial assistance from $3.5 billion to $35 billion and the amount reserved for small and regional railroads was increased from $1 billion to $7 billion. The RRIF amendments also provided that the Secretary may not establish any limit on the amount that could be used for one direct loan or loan guarantee. These changes may have a significant impact on the types and sizes of projects for which applicants may seek financial assistance, and could increase the Federal Government's risk of loss through greater exposure to the industry and concentration of the portfolio in a smaller number of borrowers.

* Requirement for Collateral: SAFETEA-LU provides that the Secretary not require an applicant to provide collateral and that any collateral provided be valued at going concern value after giving effect to the present value of the improvement. Before the SAFETA-LU amendments, FRA sought collateral to cover at least 100% of the value of the loan but never required any specific amount. Where the value of collateral is important is in the calculation of the credit risk premium, which must look at the extent to which the Federal Government would be at risk in the event of a default. By offering collateral, applicants reduce the risk to the Government and thus the credit risk premium they would have to pay. An applicant now, as before, could propose a project for financial assistance without offering collateral, recognizing that the credit risk premium will be higher than would be the case if the applicant offered collateral to cover a significant percentage of the loan or loan guarantee amount. In assessing the value of collateral, FRA will use going concern value where it is appropriate. Some applicants may choose to offer collateral that does not encompass a going concern, such as a locomotive. These are valued as they would be by any other financial institution, usually at market or net liquidation value.

* Documenting that financing is not available on equivalent terms from other sources: SAFETEA-LU provides that the Secretary shall not require that an applicant have previously sought financial assistance from another source. Prior to this change, FRA, consistent with Federal credit policy, sought to encourage private sector financing by requiring that applicants demonstrate that they had sought financing at terms equivalent to those available under the program from a commercial lending institution and been rejected. No applicant is known to have had a problem demonstrating this, in part because the RRIF program offers applicants long-term financing at Treasury rates, making it unlikely that applicants would find such low-cost financing in the private market.

*Time limit on approving a complete application: SAFETEA-LU provides that FRA has 90 days after receipt of a complete application to approve or disapprove an application. To date FRA has not found this limit to be an operational burden, given the number of applications FRA receives.

* Evaluation charge: While TEA-21 provided authority to collect an investigation fee, it was found inadequate to authorize the expenditure of funds collected. SAFETEA-LU clarifies that FRA can expend any funds collected under that authority to evaluate an application, including costs for contractors to undertake independent financial, engineering and market analyses of applicants and applications. This provision has streamlined the application review process significantly.

The Future

Since enactment of SAFETEA-LU, there has been a steady increase in inquiries about the program and railroads expressing their intent to apply in the near future. Currently, FRA is evaluating eight RRIF applications seeking a total of $2.75 billion in financial assistance.

Any discussion of the future of RRIF should address the President's FY 2007 Budget, which proposes termination of the program. In particular, the Administration is concerned about aspects of the RRIF authorization that limit FRA's discretion in managing the RRIF program and thereby potentially impeding program and risk management. For example, all railroads, regardless of size, are eligible for RRIF credit assistance, even if they are able to raise funds in the private market. In addition, the increase in the RRIF program size from $3.5 billion to $35 billion and restrictions on the Department's ability to limit the size of individual loans in the RRIF portfolio also potentially increase the program's risk of loss. Railroads already benefit from 2004 changes to the tax code, including relieving them from paying diesel taxes, further contributing to the Administration's reservations about the need to extend favorable loan terms to private rail companies.

I urge the Committee's thoughtful consideration of the merits of the Administration's FY 2007 proposal.
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Appendix 1
Outstanding RRIF Loans

Mount Hood Railroad $2.07 million 2002
Amtrak $100 million 2002
Arkansas & Missouri Railroad $11 million 2003
Nashville and Western Railroad $2.3 million 2003
Dakota, Minnesota & Eastern Railroad $233 million 2003
Wheeling & Lake Erie Railway $25 million 2004
Stillwater Central Railroad $4.6 million 2004
Iowa Interstate Railroad $32.7 million 2005
Tex-Mex Railroad $50 million 2005
The Montreal, Maine & Atlantic Railway $34 million 2005
Riverport Railroad $5.5 million 2005
Great Smoky Mountains Railroad $7.5 million 2005
Iowa Interstate Railroad $9.35 million 2006

Appendix 2
Calculation of the Credit Risk Premium

The amount of the credit risk premium to be paid by each applicant prior to drawdown of funds is calculated by the FRA using a model developed specifically for this purpose (CRP Model). This model, which has been approved by OMB, calculates the credit risk premium based primarily on two factors, the financial viability of the applicant and the value of the collateral provided to secure the debt.

Financial viability is gauged by reviewing the applicant's historical financial performance over the past five years and the financial projections for the next five years. The projections are generated by FRA based on a careful analysis of the applicant's traffic patterns, the economic environment in which the applicant operates and interviews with its largest shippers. The CRP Model uses the applicant's historical and projected financial performance and compares it to thousands of private sector companies and their default experience to generate a rating. If the applicant already has a financial rating from a rating agency, e.g., Moody's or Fitch, that rating is used in place of the rating generated by the CRP Model.

The CRP Model then uses that rating and the value of collateral offered by the applicant, if any (valued by a qualified appraiser as a going concern, as required by section 9003(f)(2) of SAFETEA-LU), to adjust projected cash flows from and to the government over the life of the loan. The net present value of these cash flows, generated using discount rates contained in the Administration's current year budget, are then used to generate the credit risk premium.

The calculation of the credit risk premium is reviewed by OMB in the last step of the approval process before the execution of legal documents to finalize the financial assistance to the applicant.