In the United States, pretty much everything we see and are awe at, suspended highways with 5-6 lanes each way, 70-story public buildings, all of it, all of it is done with bonds. All of them. Similarly, the construction of hospitals and public schools can only be done with bond loans.
Bonds are in fact a contract between an issuer, be it a municipality, a county council or a private company, or a state-owned company, and the population or investors. Investors can be pension funds, other funds, legal entities and other companies. It is a contract whereby the investor lends money to the issuer for a fixed period of time at a fixed or determinable interest rate, thus avoiding the intermediary, which is usually the bank. People, or even businesses, usually put their money in bank deposits. The bank takes the decision to invest people’s money in projects that have a higher return, often private projects. By issuing bonds the banking system is bypassed to a certain extent. Then it’s obviously a win-win situation. The average person who wants to put some money in a deposit and receives a derisory interest rate, usually insufficient to cover the taxes and fees associated with the earnings, as well as bank charges. Interest on municipal bonds is not taxable, on the other hand, and the issuer, let’s say a municipality, instead of taking bank credit at 4-5-6%, takes 3%. There is an advantage for both the investor and the issuer. Obviously, this reasoning can also be extended to companies. For solid projects, for investment projects or development projects, companies can and we are seeing more and more companies accessing this instrument on the capital market. In the United States, even governments that are not under Local Government, State Government, or the Federal Government can issue bonds. For example, there are port authorities that are not local, not state, not federal, and they can issue bonds. They can issue bonds for the development of the ports they are running. To draw a parallel, so could the Romanian National Water Agency. Some legislative changes are necessary, because the law does not explicitly stipulate – and in our country, what is not explicitly stipulated by the law cannot be – things are much simpler in the municipalities. In the case of municipalities, Law 273, the Local Public Finance Law explicitly allows local authorities to borrow by issuing bonds.
The big advantage of these bond issues is that the principal is repaid at the end. If I, as a municipality, issue 10-year or 20-year bonds worth Lei 100 million, I will pay the annual coupon to the investors, that interest to the investors, let’s say 3-4-5-6%, or 7%, whatever it will be, but the repayment of the loan capital, of the 100 million Lei, I will only pay back in 10 years. Why is this tool good? Because in 10 years’ time, when I get to the point where I have to repay that 100 million, I, as the city, will do another bond issue, also for 100 million, refinancing the first one and stretching it out for another 10 or 20 years. Just as Bucharest is doing at the moment. It’s nothing new, we haven’t discovered hot water, it’s an internationally agreed procedure, obviously, the municipality has to have a rating from one of the international rating agencies – Moody’s, Fitch, Standard & Poor’s – but it’s common practice. Why is it good? Because, unlike a bank loan, where you have a grace period of 1-2-3 years, every year you start to repay part of the borrowed capital, in the case of bonds, the repayment of the borrowed capital is no longer made from the city’s own budget, but through refinancing, also from the investments made by the citizens. The money they get from the sale of a new bond issue is used to repay the borrowed capital, the principal, as we call it, of the old bond issue. Practically, in the local economy, this means that from the taxes that I collect year after year for the local budget, I don’t have to worry about repaying the borrowed capital. From the local budget I only pay coupons to bond investors, i.e. the interest that goes directly into the citizen’s pocket, which is not taxable, unlike interest on bank deposits. Interest on bonds issued by local authorities is not taxable.
In the current context, where everyone is looking at this European wonder called the National Recovery and Resilience Program, NRRP for short, few local mayors know that they will have to include, in addition to the “free money” from the European Union, a co-financing. Most of the time this co-financing will not be at the 2% level that local authorities have got used to so far in European projects. It can be 5, 10, 15%, maybe even more in some cases. The problem is for administrative units that are already over-indebted, or are in debt up to almost the legal limit of 30%. They will not even be able to provide co-financing. Assuming that they have an accepted project that will be financed by the NRRP, and we are talking about a large infrastructure project, 15% or 10% is a considerable amount and then, how will these territorial administrative units be able to provide this co-financing share, as they have nowhere to do so. The local budget doesn’t allow them, they don’t have enough money, they can’t take other bank loans, because they have already reached this high level of indebtedness, and then the solution is municipal bonds. With municipal bonds, they can refinance all the loans they have accumulated so far and postpone them, push the repayment of this money, 10 years from now, when they can do a new issue. In a roll-over operation, it relieves the local budget from paying back the capital borrowed so far. Obviously, when you no longer pay annual capital repayments, as you do with bank loans, that money that remains is a saving that can be used to co-finance projects in the NRRP.
We thus see that there are multiple advantages of bonds over bank loans. The advantages are first of all that you have all the money, you can get on with the project and you can complete it much faster. You don’t wait for the money to keep coming in, another application to be approved, another tranche of funding to be approved and so on. On the one hand, this is an advantage, on the other hand it’s a disadvantage, the disadvantage coming from the fact that you start paying interest as an issuer from the day immediately after. You have 100 million – you can’t spend it all in one day and then, from the point of view of financial mechanisms adapted to the issuer, the preferred solution is to have a bridge loan for a period of investment realization of 6 months, 8 months, one year, followed by refinancing this bridge loan through a bond issue.
I’ve seen a lot of news about private companies launching bond issues lately. Obviously, this news is more than welcome. What I don’t find as gratifying is that many of these news stories triumphantly report that oversubscription has occurred. I don’t know if it’s right. I don’t know if it’s right, why? Because this oversubscription? It means that the supply of bonds is undersupplied relative to the demand or it means that the coupon offered is much better than the market would have expected, otherwise there would not have been oversubscription. Or a combination of the two. But more often than not, oversubscription occurs because the interest offered on bonds is higher than the market would have been willing to swallow. And where is the triumph? Me, putting myself in the shoes of the CEO of the company that issued the bonds, why am I paying too much interest? Why was I not able to adjust this interest rate to a realistic interest rate? Not to deal with oversubscription, the intermediary or the broker to make considerable efforts to sell, because in the spirit of the economy that I as CEO have to make for my company, and in the spirit of the responsibility I have towards the shareholders, the interest that I offer on the bonds is actually a reduction in the profit for the shareholders. If I offered a higher interest rate on the bonds, that’s to the detriment of my shareholding. This can be replicated in government bonds. If they were oversubscribed it means that the interest was very good, very high, but a very high interest on those bonds actually means a disadvantage for the tax payers. It means that of the money paid by them, by taxpayers, in the form of taxes, some of it went, unjustifiably, on those coupons, interest on bonds. Is this proof of incompetence? I’m afraid so. The role of a CEO of a company that issues bonds, or of a territorial administrative unit that issues bonds, of a municipality, or even of the government that issues government securities, is to look after the shareholders. The interest rate at which it issues should not be too high, so that it spends public money or shareholders’ money efficiently.
