Energia - Środowisko - Infrastruktura
Dodatek promocyjno-reklamowy do "RZECZPOSPOLITEJ".
21 marca 2006 r.

A way to finance municipal investments

Revenue Bonds

Interview with Błażej Borzym, Director of Treasure Department, Bank Pekao SA and Maciej Lewandowski, Director of Debt and Structural Financing Bureau, Citibank Handlowy - representatives of MWiK's Revenue Bond Programme organizers.

The Bydgoszcz Programme for Development of Water and Sewage Services will be financed, among others, by revenue bonds. Both of you participated in arranging the revenue bond issue by Miejskie Wodociągi i Kanalizacja in Bydgoszcz (MWiK). Let us clarify: what are revenue bonds?

Maciej Lewandowski: Revenue bonds were introduced to the Act on Bonds in 2001. Their main purpose is to allow public sector entities to obtain considerable resources for infrastructure investments. Revenue bonds, as the name suggests, are repaid and secured by income generated by the constructed and modernized infrastructure over a very long time. The long-term aspect of this tool allows for secure debt payback even at low investment income. However, of key importance for the issuer and the investor alike is to assess a stable level and variability of this income.

Who can issue this type of bonds?

Błażej Borzym: In line with the mentioned Act, revenue bonds may be issued by local units of government, companies active in the public sector (in the broad meaning of this term) whose major shareholders are local units of government, and companies which provide public services under licences and permits. Since, as we know, such entities do not aim at generating income, it is usually more difficult for them to access long-term financing. At the same time, the demand for infrastructure investments is huge and usually exceeds their capability to service and pay back traditional loans or unsecured bonds.

Are such solutions for financing municipal investments popular in other countries?

ML: The most mature revenue bond market is the United States where in 2004 the value of bonds issued to finance projects in education, transport, public utilities and residential housing reached 230 billion USD. The main bond acquirers are pension and investment funds but also, due to tax relief, natural persons. While preparing the transaction for MWiK, we drew upon experience of our colleagues from Citigroup in the USA.

Why is it worth financing infrastructure investments through revenue bonds? What are the benefits for the municipality or the municipal company from obtaining these resources?

BB: Let us look at the MWiK example. In the case of this transaction our goal was to obtain long-term financing for a concrete investment project without involvement of the city budget. It is worth noting that the value of bond issue programme is 600 million PLN which accounts for around 80% of the budget income for Bydgoszcz. The city alone would not have been able to fully finance the project without limiting other investments.

This is a typical situation facing local authorities when a comprehensive investment (waste and sewage system is built once every several decades) requires resources that are beyond their financial capability. Spreading the investment over many years is a potential solution but it leads to increase in both project costs and service charges - fewer customers at the beginning of the investment leads to a limited use of assets which, in turn, increases service charges.

ML: In the case of water and sewage investments, of key importance are also implementation deadlines of EU environmental directives. This means that certain investments should not be postponed. The dilemma for local governments may be compared to that which is faced while constructing a house: should we save up money to construct one room a year or issue bonds and construct the whole house in a short time and then repay the debt in the long term from additional income.

The example of MWiK and the city of Bydgoszcz shows how to realize ambitious ideas and finance over half of the investment through EU funds.

And what about municipalities which did not separate infrastructure but plan investments?

ML: As we have said earlier, revenue bonds may be issued also by municipalities. What is more, in line with the Act on Public Finance, this type of debt is not taken into account while calculating debt indexes. In this case we can talk about the so-called extra-budgetary financing. The only requirement is to define the project and identify revenue necessary to pay it back.

What conditions must the municipality or the municipal company meet to issue revenue bonds?

BB: We have already spoken about legal requirements but we should also remember that bond buyers will assess risk of a given entity and investment. Thus, the lower the perceived risk, the better the financing conditions (lower cost, longer payback term).

We can say from the experience gained during this pioneer project that a company must pursue a clearly formulated business strategy aimed at improving business performance and meeting customer expectations. Since MWiK's investment plans were very ambitious, the company had to prove its experience in implementing other investment projects.

At the same time, the Act on Bonds imposes broad obligations on bond issuers mainly with regard to allocation of project resources and income. That is why, the financing or controlling department must be prepared to provide detailed information on the project.

ML: It is also important for municipal companies to be supported by its owner - the municipality or the city. This may include lending financial support, relieving administrative burdens or imposing an obligation of non-discrimination of potential competition.

Who bought MWiK bonds and what resources do potential investors have?

BB: The first tranche of bonds was bought by pension funds, insurance companies which look for long-term secure investments and banks which fulfil a stabilizing role in this transaction.

The resources of potential investors amount to around 150 billion PLN (pension funds - around 60 billion, insurance companies - around 50 billion, and investment funds - around 40 billion). This is a huge sum of money and it is obviously impossible that all of it is invested in revenue bonds, but already 10% of it would exceed the required amount of own resources needed for water and sewage investments in the years 2006-2015.

MWiK bonds were awarded an investment rating by Fitch Ratings. What benefits does it bring?

ML: Investors such as pension funds want to be sure that resources invested by future pensioners will be returned on time. That is why, specialized rating agencies, such as Fitch Ratings, evaluate creditworthiness of the company and/or the municipality examining their business and investment potential.

The assessment methodology applied by these agencies allows to compare companies and municipalities form different countries. Our banks advised MWiK during the rating process. In November 2005, Fitch Ratings awarded the company and the city of Bydgoszcz a long-term BBB- investment rating.

Investment rating not only increases the number of potential bond buyers but also has a marketing effect for the company which joins the prestigious group of best borrowers in Poland. MWiK is the first company in the water and sewage sector in Poland and Central Europe to be assigned a bond rating by an international rating agency.

What role did the city authorities play in this project?

BB: Improvement of infrastructure and living conditions is one the priorities for Bydgoszcz and MWiK investments are consistent with its development strategy. From the beginning, the city gave priority to this project and continuously supported MWiK. Participation of city authorities in meetings with the rating agency and investors positively influenced the perception of the project risk.

How can banks assist beneficiaries in pursuing this type of financing and in using EU grants?

ML: In the case of MWiK revenue bonds, we have managed to combine the expectations of the issuer - by obtaining considerable financial resources - the expectations of the municipality - by ensuring timely implementation of its project and adequate level of service charges - as well as the expectations of investors by ensuring high quality income which guarantees security of invested resources in the next 18 years.

While arranging this transaction, our banks drew upon their long experience in the financial market. For over 10 years, Bank Pekao SA has been active in the municipal bond market and perfectly knows the specificity of the Polish market and Polish local governments. Citibank Handlowy is a leader in corporate bond market and is part of the world's largest financing institution with wide international experience.

BB: We think that revenue bonds are a good long-term form of investment financing. They remove barriers to obtaining own resources for financing EU supported projects and, as a result, speed up and expand investments. EU funds must be used within a set deadline otherwise they may be irreversibly lost. That is why we believe that it is now extremely important for municipalities to prepare as many good investment projects as possible.

Implementation of these projects will help us catch up with European Union levels. With our experience we are able to obtain EU funding for many projects.

ML: Revenue bonds are an innovative form of financing in our market. The example of MWiK shows that local units of government and their companies implement modern management solutions and that their staff is well prepared for managing finance and investments in an effective and flexible manner.

BB: MWiK's revenue bonds issue helped not only us but the company itself and the city of Bydgoszcz to gain new experience and put to work many financial and legal solutions. The results are, as we see, very good. We appreciate the confidence vested in us.

Thank you.

MM