How Should Water and Sewer Systems Invest Bond Proceeds?

A water or sewer system invests its bond proceeds by matching each fund the bond documents create (construction, capitalized interest, debt service and reserve funds) to an investment horizon and a product that can live with that fund's spending calendar, inside the limits the federal arbitrage rules, state law and the indenture set.

This page is the water and sewer entry in mGIC's guides to how reinvestment differs by issuer sector, and it follows the order of the series: structures, funds, products, compliance and named transactions.

The short version: a construction fund drawn on its drawdown schedule across a capital program and a debt service fund matched to the revenues the bonds are payable from set the shape of the investment problem, and the fund types guide is the cross-sector companion to what follows.

What financing structures do water and sewer systems use?

Water and sewer systems commonly finance with revenue bonds, which the MSRB glossary defines as a bond payable from a specific source of revenue, with pledged revenues that may come from project operations, grants, or excise or other non-ad-valorem taxes.

The same glossary entry notes that generally no voter approval is required prior to issuance of such obligations, a general point that carries a caveat: voter-approval rules vary by state.

A second structure is the private activity bond: water and sewage facilities are among the exempt facility categories IRS Publication 4078 lists under section 142, and under 26 U.S.C. §141(e) a private activity bond can still be tax-exempt when it is a qualified bond that also meets the applicable volume cap under §146 and the requirements of §147.

Publication 4078 notes that airports and docks are not subject to the volume cap, and it adds a spending condition for qualified private activity bonds generally: 95% or more of net proceeds must be used for the qualified purpose.

The GO vs revenue bonds guide covers the difference between tax-backed and revenue-backed debt, and the private activity bond guide takes the exempt facility rules up in full.

Which funds hold the proceeds, and what are the draw profiles?

A water or sewer system's proceeds sit in the funds its bond documents create, and the fund types GFOA's best practice describes carry typical investment horizons: a construction or project fund for the capital program, a capitalized interest fund, a debt service fund and a debt service reserve fund.

GFOA frames these as typical ranges rather than rules, says expectations vary, and directs issuers to their advisory team and investment policy.

The sector's draw profile pairs a construction fund drawn on its drawdown schedule across the capital program with a debt service fund matched to the revenues the bonds are payable from, and GFOA recommends making sure an investment's duration is no longer than the expected drawdown schedule and revisiting the draw schedule periodically, with estimating the construction side covered in the draw schedule guide.

The tax rules then pick out a subset of the debt service side: under Treasury Regulation §1.148-1(b), a bona fide debt service fund is one used mainly to match revenues with principal and interest within each bond year, and it must be depleted at least once each bond year, except for a reasonable carryover not exceeding the greater of the prior year's earnings on the fund or one-twelfth of the prior year's principal and interest.

Everything the funds hold sits inside the arbitrage definitions: gross proceeds means all proceeds plus all replacement proceeds of an issue, and proceeds in turn means sale proceeds, investment proceeds and transferred proceeds (Treas. Reg. §1.148-1(b)).

Sale proceeds are the amounts actually or constructively received from selling the issue, including amounts used to pay the underwriters' discount and accrued interest other than pre-issuance accrued interest.

Investment proceeds are amounts received from investing proceeds, net sale proceeds subtract the amounts placed in a reasonably required reserve or replacement fund and the minor portion, and transferred proceeds are proceeds of a refunded issue that become proceeds of the refunding issue under §1.148-9.

Rate revenues raise a separate question, because replacement proceeds under §1.148-1(c)(1) are amounts with a sufficiently direct nexus to the issue or its governmental purpose that they would have been used for that purpose if bond proceeds had not been available, a category that includes sinking funds and pledged funds.

Whether a particular utility account crosses that nexus is fact-specific, which is why the replacement proceeds guide treats it as its own question and why bond counsel makes the call.

How do the reinvestment products fit water and sewer proceeds?

The products that fit a water or sewer system's funds are the same three families used across sectors: guaranteed investment contracts, full-flex repurchase agreements and structured portfolios of U.S. Treasury securities, which mGIC helps issuers evaluate and competitively bid without selling any of them.

A guaranteed investment contract is, in the MSRB glossary's general definition, an investment secured by a contract with a financial institution that guarantees a fixed rate of return and a fixed maturity, and the tax regulation's definition also includes any nonpurpose investment with specifically negotiated withdrawal or reinvestment provisions and a specifically negotiated interest rate (26 CFR 1.148-1(b)), the negotiated form behind the flexible draw schedules bond-proceeds GICs often have.

The match runs off each fund's spending pattern and on what the issue's documents and the tax rules provide for that fund to hold: for GIC purchases, the terms of the solicitation must take into account the issuer's reasonably expected deposit and drawdown schedule (26 CFR 1.148-5(d)(6)(iii)(A)(5)), which is what ties withdrawal terms to a construction fund's draws, and the GIC guide covers credit protection and withdrawal provisions.

The reinvestment products guide maps each family, and the GIC vs flex repo comparison lays the two contracted forms side by side.

Treasury's SLGS securities are a separate lane: 31 CFR 344.1 limits purchases to an eligible source of funds, a list that starts with gross proceeds of tax-advantaged bonds and also takes in amounts held with them in refunding or defeasance escrows, parity reserve funds or commingled funds, and other yield-restricted amounts.

Whether a particular fund a water or sewer system holds falls within those categories is a question for bond counsel.

The offering also has a known interruption mode: 31 CFR 344.2(l) reserves Treasury's right to change or suspend the terms when the Secretary determines that issuing obligations sufficient for the orderly financing operations of the United States cannot be done without exceeding the statutory debt limit.

During such a contingency, 31 CFR 344.7(b) lets Treasury move unredeemed Demand Deposits into special 90-day certificates of indebtedness that earn simple interest at the daily factor in effect when Demand Deposit issuance was suspended and roll over if the contingency continues.

One vocabulary note for utility staff who also touch pension portfolios: the stable value contracts the CFTC and SEC described in a 2011 release, bank or insurer wraps that pay plan participants at book value when a stable value fund's market value falls short, are a different product and regulatory setting from the investment agreements bought with bond proceeds.

Whether a local government investment pool is an eligible investment for a given fund is a separate question, and the local government investment pool guide takes up the pool-versus-bid question.

What sector-specific compliance applies, such as private use?

The compliance question specific to water and sewer financings is private use: when the financing is a private activity bond, the qualified-bond conditions, the volume cap and the arbitrage rules all attach, and when it is not, the ordinary governmental-bond rules carry the analysis.

The arbitrage rules reach these bonds too, with differences: when the correct rebate is not paid on time, the bonds become arbitrage bonds unless the failure was not due to willful neglect and the issuer promptly pays a penalty plus interest, with the penalty set at 50% for governmental and qualified 501(c)(3) bonds and 100% for other bonds (Treas. Reg. §1.148-3(h)).

On the definitions side, the analysis runs on gross proceeds, and the spending exceptions apply special modified definitions of gross proceeds rather than the general one.

Because the bonds are payable from system revenues, the question of when pledged amounts or sinking funds become replacement proceeds recurs across a utility's accounts, and the nexus test above is what answers it.

Whether a given water or sewer financing is a private activity bond, and which exceptions and definitions apply to its funds, is a legal and tax determination for bond counsel and tax counsel.

The recordkeeping that follows closing is its own subject, covered in the post-issuance compliance guide.

Which representative transactions involve water systems?

Birmingham Water Works is the water-sector name in mGIC's list of representative transactions, alongside names that span transportation, public power, aviation, higher education and student housing, and the case studies hub is where the deal pages live.

Those pages name transactions only: no deal's size, structure, provider, rate, number of bids or result is published for a named transaction.

Across the practice, mGIC's record is more than $60 billion in bond proceeds invested and swap notional executed, across more than 1,000 transactions for issuers in more than 40 states, with reinvestment the focus since 2002.

The work divides into reinvestment advisory, Bidding Agent services and documentation and settlement, and the fee is paid by the winning provider rather than the issuer, at or below the safe-harbor maximum in the Treasury arbitrage regulations, and disclosed.

For an independent read on how a water or sewer system's funds line up with its documents, draws and tax deadlines, you can talk to mGIC about a free, no-obligation reinvestment review.

Final determinations about a specific issue, from private activity bond status to which exceptions apply, belong to bond counsel and tax counsel.

Last updated 2026-10-06.

This page is general educational information about municipal finance and federal and state rules as of the date shown. It is not legal, tax or investment advice, and it is not a recommendation about any particular investment. Product availability, legality and suitability depend on the issuer, jurisdiction, governing documents and transaction-specific facts. Final legal and tax determinations remain with the issuer's bond counsel, tax counsel and other advisors.