Municipal loans – advantages and limits

16 March 2006 (Invest Romania)

Part of municipal management, financing development programs and projects represents, in terms of complexity, a difficult task for the local administration. Municipal projects often exceed local budgets, requiring complex financial mechanisms, respectively advanced financing.

In addition to auto-financing and public – private partnerships, lending by way of bank loans and/or issuance of municipal bonds is the main modality of financing municipal development funds.

Apart from the limits entailed by auto-financing or advantages of public-private partnerships, municipal loans allow for a more effective project implementation, ensuring equal allocation of investment costs in time, as well as equity between generations bearing such costs and those benefiting from the positive effects of such projects. Moreover, with respect to urban development projects, such benefits, often difficult to quantify, could be associated with the creation of new working places, increase in productivity, improvement of business or life or revitalization of historic patrimony.

Romanian municipalities are entitled to contract loans and place securities on loans contracted by subordinated undertakings and public services, according to the Local Public Finance Law (the “LPF Law”). Such loans may consist of internal or external loans, on short, medium and long term, either in foreign or national currency, with fixed or floating interest.

Conditions and/or limits imposed upon municipalities in contracting loans are mainly related to the scope and maximum amount of the loans. Regarding the scope, the LPF Law restricts the possibility to contract loans to two general cases - public investments of local interest and refinancing the local public debt – respectively, to infrastructure projects pertaining to the public domain.

As to the maximum amount of the loans, including also the maximum amount of securities granted - similar to other countries, maximum indebtedness thresholds have been imposed to Romanian municipalities. LPF Law forbids municipalities from contracting or setting up securities of any kind, if annual aggregate debts representing the outstanding due rates to the contracted and/or guaranteed loans, related interest and commissions, including the loan to be contracted and/or guaranteed during the concerned year, exceed the threshold of 20% from the aggregate own income.

To compute such maximum threshold for the contracted and/or guaranteed loans, with a variable rate of interest, calculations shall consider the interest rate valid upon drafting the documentation. In this view, loans granted in foreign currency shall be considered at the value of the exchange rate of the National Bank of Romania upon calculation date.

Regarding the authorisation to contract loans/set up securities, LPF Law does not condition execution of the loan and guarantee contracts of a prior notification or procurement of an approval from central public administration authorities. Complying with the procedure and conditions for approving the loans/ guarantees, as provided by the LPF Law (i.e. decision taken based on qualified majority representing 2/3 of the members in approving bodies) is both necessary and sufficient.

Regarding guarantee means, for either own or contracted loans by subordinated undertakings and public services, municipalities have the legal possibility to set up securities either (i) from their own revenues (i.e. assignment of the right over the amounts resulting from taxes, fees, divided quotas from income tax) or (ii) by placing real securities (mortgages) over real estate, private property of municipalities (a disadvantage for creditors taking into consideration the difficult implementation proceedings).

Assignment of own revenues represents one of the most efficient means of guaranteeing municipal loans, even more in the current context where transfer quotas to the state budget are set according to a pre-established algorithm. Expressly provided by LPF Law as a guarantee means available to municipalities, assignment of revenues grants the lender the right to a first claim not only with respect to own income but also with regard to transfers from the state budget, otherwise designated to concerned local public administration.

On the other hand, real guarantees present a series of disadvantages. Despite the fact that relevant legislation has been amended with a view to accelerating enforcement of assets set up as securities, the actual valuation and/or effective entry into possession of the assets set up as securities is difficult in practice, or in the best case, time consuming. Such elements eventually lead to a greater diminishing of the real property value, set up as guarantee. The Patrimony Law, based on which properties pertaining to the “private domain” and therefore eligible to be used as securities are established, has been partly implemented, adversely influencing the municipalities ability to use real property as securities.

Other countries’ experience reveals that, in practice, it is very difficult for private creditors to enter into the possession of fixed or real assets set up as securities by local authorities under insolvency. Most of developing countries or countries in transition tend to use mainly financing by general bonds – debt guarantee by aggregate future budgetary revenues of the local authority.

From the creditors’ perspective, non-observance of the municipalities’ undertakings arising out of loan contracts, triggers application of general legal provisions on enforcement and execution of guarantees. Absent a regulatory framework pertaining to municipalities’ insolvency, monitoring and intervening in cases of blockage are ensured by the Ministry of Public Finances that is entitled to grant interest loans to the municipalities, provided that such loans are reimbursed within maximum 2 years.



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