November 7, 2014

A new funding model for local government

Changes to the financial sector’s Basel III rules are making it expensive for councils to borrow from banks. NAB’s James Waddell explains how the Local Government Funding Vehicle (LGFV) will create efficiencies, reduce borrowing costs and open up new avenues for local council finance.

Changes recently made to the financial sector’s Basel III rules are making it increasingly expensive for councils to borrow from banks.

Historically, local councils in Victoria have accessed bank loans for their financing needs. As no Australian council has ever defaulted on a loan, banks have considered lending to local councils as being particularly low risk. However, as Director of Institutional Product Development at NAB, James Waddell explains, this became a problem.

“Given the safe nature of these borrowers, banks have previously provided very long dated loans to councils,” say Waddell. “But under new Basel III rules, banks are now required to ‘match fund‘, that is match a long term loan to a council by borrowing for a similar period themselves, which has made borrowing from banks more expensive for councils.”

The Municipal Association of Victoria (MAV) approached NAB to work on delivering a solution that would provide an optimal outcome for their members – and from this, the Local Government Funding Vehicle (LGFV) was created.

“It’s a really simple concept,” says Waddell. “The LGFV is a trust that makes loans for councils while issuing bonds for investors that finance them. The bonds are provided on equivalent terms to the loans, such as having the same maturity dates, and while the loans are not rated, the bonds carry a credit rating of Aa2 from Moody’s investor services. That’s a better rating than those of major Australian banks, so Victoria’s local councils can now borrow debt at a lower cost than before.”

This new borrowing model will create efficiencies, reduce the borrowing costs of local councils and, as it has in other jurisdictions, open up new avenues for local government finance. “The money saved by councils will create an opportunity for councils to reduce their council rates and/or free up cash flow to reallocate to community services,” says Waddell.

But it seems the biggest mystery about the LGFV so far is why it’s taken so long for the concept to be applied in Australia. “This type of funding structure already exists overseas in countries such as New Zealand, Canada, the UK and Scandinavia,” say Waddell. “Lenders such as Kommunalbanken in Norway have a public policy mandate from the central government, so they’ve been providing low cost finance to the Norwegian local government sector since 1926. While in New Zealand, the Local Government Funding Agency has been lending to councils since incorporation in 2011.”

Working side by side with the Commonwealth Bank (CBA), the Municipal Association of Victoria (MAV) and Ernst & Young, NAB and its related entities acted as arranger, lead manager, Trust Manager and Trustee in establishing the LGFV program. And while Victorian local councils have taken the first step with the LGFV, the door’s now open for other states to establish similar programs. “Through their Treasury Corporations, State Governments in Queensland and Western Australia have acted as a lender to the local government sector in their respective states, but this approach comes with its own issues,” says Waddell. “We look forward to discussing the brave new world with them.”

As a leading lender to the local government sector as well as a market leading debt capital markets house in Australia, NAB has a team of specialists that can develop funding and investment solutions for businesses and investors.