- Compared to government securities, the purpose of the funds raised through municipal bonds is to develop local infrastructure so as not to put additional pressure on the budget
- “As these municipal bonds become accessible to the retail public, we will obviously see the migration of the amounts existing today in bank deposits to the capital market.”
Municipalities in Romania are preparing to raise RON 2.3 billion by spring 2024 through municipal bond issues, which will support local infrastructure development plans and allow large investors to diversify their portfolios. Thus, three bond issues were approved by Reșița, Piatra Neamț and Cluj County Council. Also, Districts 3 and 4 of the Capital City and Prahova County Council are currently analyzing this type of listing.
Now, 35 issues of municipal and county bonds totaling RON 2.5 billion are listed on the Bucharest Stock Exchange. In other words, in just a few months, the value of these financings on the Stock Exchange will almost double, which means that investors who will subscribe to these financings will get a new breath of fresh air, given the reduced activity in recent years in the municipal financing segment.
ZF spoke to Valentin Miron, CEO of VMB Partners, a company that has consulted 27 of the 35 municipal issues listed on the BVB.
“Through these operations, private money to finance local infrastructure is put into the circuit. This in fact means that the City Hall does not rely solely on the local budget, on transfers from the state budget or on European aid (which are all in fact an expression of a minor percentage of the population’s income, representing taxes), but on the infusion of private capital with much larger amounts than those collected from the local budget, thus allowing a faster development of infrastructure (let’s not wait another 35 years to have new county hospitals, for example)”, says Valentin Miron.
For now, there are two types of municipal bonds on the Bucharest Stock Exchange, bullet and amortized bonds. As the name suggests, amortizing mortgages involve annual repayments of principal until they are repaid in full, while bullet mortgages involve repaying the principal in full once, in full, at maturity.
In contrast to government bonds, whose funding goes to patching the budget by reducing the deficit, the purpose of the funds raised through municipal bonds is to develop local infrastructure in order to avoid putting pressure on the budget, which is basically based on taxes.
“As for Bucharest, the only administrative territorial unit that has issued in Romania in the last 10 years, the yield on the April 2022 issue, denominated in RON, is 8.9%. All these yields, both for the municipality of Bucharest and for government bonds, do not reflect the country’s rating, GDP growth, improvement in the trade balance or exchange rate stability. The only thing reflected is increased spending in the state budget sector and the fact that investors automatically expect municipal bond yields to be higher than government bond yields. However, this somewhat truncated perception leads to the expectation that future municipal bond issues will have to offer, depending on the rating of the respective municipalities, a positive spread compared to government securities with similar maturities”, adds VMB Partners’ representative
In addition to developing local projects, from infrastructure to hospitals and kindergartens, municipal bonds also support the liquidity of the stock market, but this is also where legislation should be improved.
“As these municipal bonds become accessible to the retail public, we will obviously see the migration of the amounts that are today in bank deposits to the capital market. This will certainly generate better liquidity and market atomization. In order to become more liquid, in the future, we intend to include in the structure of municipal bonds put time clauses up to 5-10% of the total amount issued each year. What does this actually mean?”
It means that there is a guaranteed buyer, namely the municipality, at face value, when an investor wants to exit the position, says Valentin Miron.
He goes on to say that, due to the exception provided by the European Union Regulation 1129/2017, the prospectus of municipal bonds does not fall under the obligation to be authorized by the Financial Supervisory Authority. In this context, it is considered that they cannot, for the time being, be the subject of public offerings, but only of private placements.
Subsequent discussions with FSA led to the conclusion that it is necessary to adopt an Emergency Ordinance supplementing the existing legal framework, i.e. Law 126/2018, so that municipal bonds can be sold through public offer. This would be consistent with the way municipal bonds are issued in many European countries and, in fact, worldwide.
“We insist on the urgent need to adopt these additions to the existing legal framework because, obviously, retail investors in a locality have every interest to buy bonds of the respective municipality to invest in the process of upgrading and development of public infrastructure of local interest (schools, kindergartens, hospitals, roads, sewage treatment plants, etc.). Moreover, by allowing the general public access to bond offerings, the secondary market will become much more atomized, generating a significant increase in liquidity”, explains Valentin Miron.
On the other hand, the way in which the coupon values are set would be the result of the correlation between supply and demand. In practice, the yield on these bonds will no longer be determined, as at present, by direct and relatively opaque negotiation between the issuer and the syndicate, but by the stock exchange through a public and transparent mechanism for matching supply and demand.
The municipal bonds are secured by the assignment of receivables owed by the municipality, i.e. local taxes and duties as well as income tax. The level of risk of municipal bonds depends to a large extent on the size of the population, current economic development and the level of employment of the resident population. Thus, a locality with very low unemployment generates, through the 63% share of the income tax paid to the local budget, a substantial operating income, which is the main source of repayment of payment obligations when due.
“It is impossible to believe that, for example, 10,000 firms or 50,000 employees would leave a city with a high level of employment in a single year. This, in fact, means that changes in income tax receipts are insignificant from year to year. If the locality has a decent level of economic development and relatively low unemployment, the risk is extremely low.”
Turning to the benefits, one of the main advantages of bond issues, especially those structured according to a clear and well-defined long-term program, is that they relieve the local budget from debt. Art. 63 para. (4) of Law No. 273/2006 on local public finances prohibits the contracting of new local public debt if there are payments representing the service of the existing debt that exceed cumulatively, in one year, 30% of the average annual own revenues of the last three completed financial years of the territorial administrative unit.
Although the funds obtained from the sale of these municipal bonds are generally used for the purpose of pre-financing and/or co-financing projects that partially benefit from non-reimbursable European funds (POR, POIM, etc.) and this situation falls under the exception provided for in Article 63 of the above-mentioned law, nevertheless, for reasons of budgetary prudence, as well as to maintain financial indicators of indebtedness that meet accepted international standards, the repayment of the principal will be made in several annual installments, for example in the last three years until maturity.
“This reduces the issuer’s indebtedness between the above-mentioned years, compared with a bank loan, which does not usually allow a grace period of more than two to three years. Structuring the bonds in this way allows additional public debt to be incurred during the first five to six years of the bonds’ life, without substantially burdening the issuer’s indebtedness”, points out the CEO of VMB Partners.
In fact, the possibility of repaying the principal in several annual installments is not only a feature aimed at ensuring formal compliance with the provisions of Art. 63 para. (4) of Law 273/2006, but it is rather a solution to address the risks related to the issuance of new bonds intended to ensure the roll-over of the existing issue.
If the bonds are correctly structured according to its needs, they can generate, through successive scheduled refinancing operations, a synchronization of the lifetime of infrastructure projects with the summed periods to maturity, says Valentin Miron.
Specifically, if a building that is bond-financed and has a 50-year lifespan, it is socially inequitable for that building to be financed by the taxes of today’s generation.
“It would be socially equitable if this infrastructure investment goal could be funded by the taxes of all generations of taxpayers who use it. Unfortunately, no financial banking institution, whether domestic or international, offers 50-year loans. Nor do bonds (currently) offer a 50-year maturity. But through several successive bond issues, we can reach this cumulative maturity equal to the life of the infrastructure in question,” VMB Partners representative told ZF.
