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Weekly UpdatesMunicipalities around the globe differ in many respects, but one thing most of them have in common is a desire to obtain the best possible financing terms so that public funds can be directed to the benefit of constituents, not to pay for high interest rate debt service requirements. Local governments have devised many creative ways to lower their borrowing costs. In Sweden, local governments found that they could obtain more cost-effective financing by working together. This article describes Kommuninvest, a triple-A-rated financing cooperative that saves several million Swedish kronor each year for participating governments.
LOCAL GOVERNMENT IN SWEDEN
In Sweden, 20 regional county councils and 290 municipalities share responsibility for providing services to local residents. Municipalities are responsible for social services, care of children and the elderly, public utilities (energy, water and sewage, refuse collection), primary and secondary education, road maintenance, housing development, rescue service, and environmental protection. County councils are responsible for hospitals, healthcare and preventive medicine, and public transportation. Municipalities and county councils have the right to make decisions in all local government issues without first presenting these before any central government body. The income tax is the primary source of revenue for Swedish local governments. Other sources of revenue include grants from the central government and charges for direct services such as water and sewer. The county councils and municipalities set the tax rates as part of the annual budget development process. The central government has a system to equalize taxing authority and structural cost differences among municipalities.
Kommuninvest was created as a reaction against the unreasonably high cost of financing key investments in the social structure at the local government level. All over the country elected officials and finance officers had become frustrated by the fact that interest payments were consuming an ever-greater share of the funds available for essential municipal services. By coordinating their borrowing requirements, Swedish municipalities found that they were able to obtain lower interest rates than those offered to any individual local government. Moreover, they found that the cooperative model kept overhead costs to a minimum.
Kommuninvest is a credit market company. Swedish municipalities and county councils are granted membership in the cooperative after passing a thorough analysis of their financial condition. Kommuninvest works as a municipal debt office, acting solely at the direct request of the members and always in the best interests of the municipal sector. From the very beginning, its prime objective has been to provide a source of cost-effective long-term financing for municipalities and county councils in Sweden. Kommuninvest also offers added value in the form of advisory and training services.
Kommuninvest commenced operations in 1986. Initially, participation was limited to municipalities in the County of Orebro. However, credit market developments and Kommuninvest's success in securing more favorable financing terms for its members generated a great deal of interest among municipalities and county councils in other parts of Sweden. After some restructuring work, municipalities and county councils outside Orebro were allowed to participate in Kommuninvest beginning in January 1993. Since that time, the cooperative has experienced tremendous growth.
Kommuninvest is the largest inter-municipal cooperative society in Sweden. More than half of Sweden's municipalities (154 of 290) and five county councils are now members of the cooperative. In the last five years alone, membership has increased by 45 percent and lending has almost doubled. More and more municipalities and county councils are seeing the advantages of arranging their financing through Kommuninvest and are applying for membership.
President and CEO Thomas Akelius describes Kommuninvest's growth: "Kommuninvest has developed dramatically since the start, and today we are a significant force in the Swedish economy. At one point, the chairman of the Parliamentary Standing Committee on Finance pointed out that Kommuninvest's balance sheet total amounts to more than Sweden's national defense budget."
HOW IT WORKS
Lending is made exclusively to members of Kommuninvest or companies controlled by the members, so the cooperative's risk exposure is limited to the credit risk of Swedish local governments. Kommuninvest offers maturities of up to 20 years, either on a fixed or floating rate basis. The rate structure can be changed from fixed to variable or vice versa whenever the borrower wishes. To make the most of opportunities for good interest rates in the market, it is possible to fix interest rates with a future settlement date, while capped rates and interest floors are available for floating loans. Member governments borrow only in Swedish currency.
From the beginning, Kommuninvest has used long-term loans to finance the investments of member municipalities and their municipally owned companies. The members have chosen to adopt a rather restrictive policy toward new investments, which means that most of Kommuninvest's lending is used to refinance existing debt. The cooperative strives to ensure that its pricing over the duration of the loan is among the best available for the specific type of loan being sought. The high acceptance rate of Kommuninvest's quotations is evidence of its competitiveness.
Kommuninvest's financing strategy is to diversify funding in order to obtain the best possible conditions over the long term. Pricing is maintained continuously and issues are made in structured or straight loans with maturities generally ranging from three months up to 30 years. Borrowing is divided among the Swedish, European, and Japanese capital markets. To achieve the most cost-effective loan conditions over the long term, Kommuninvest takes an active role in educating the capital markets about the creditworthiness of Swedish municipalities and in explaining Kommuninvest's role as a "national debt office" for member municipalities.
An extensive network of contacts in capital markets worldwide gives Kommuninvest access to independent sources of financing without any restrictions on individual banks or markets. Consequently, the risk associated with financing for the municipal sector as a whole is much less than what can be expected by individual municipalities.
Kommuninvest has become an increasingly important player in the capital markets. In 2004, Kommuninvest became one of the largest issuers of structured bond loans on the Swedish market. It is one of the world's most active issuers in the Euro Medium Term Note market, with EUR 10 billion in the EMTN program. And in January, Kommuninvest took out the largest single loan in its history in the form of a public bond issue of USD 1 billion.
FINANCIAL SUPPORT SERVICES
Aside from lower borrowing costs, members of Kommuninvest benefit from the organization's combined expertise through a range of different financial models and methods. Information communicated via Kommuninvest's weekly newsletter complements a full range of financial support services that includes:
* Financial analysis. A model that a municipality or county council can use to establish its own financial strength. The results can be used to formulate a financing policy, or as a free-standing basis for discussions.
* Financing policy A model that helps a municipality or county council formulate a balanced, well-founded debt policy.
* Debt portfolio analysis. An IT-based model for analyzing, optimizing, and monitoring a debt portfolio.
* Business Watch. Customized, real-time information on interest rates, currencies, and other important financial news that is sent directly to members' workstations.
Members can access these four services through the Internet. These services are further supplemented by regular training and a personal advisory service. Advice can encompass other financial areas in which Kommuninvest or its business partners have particular expertise.
MEMBERSHIP IN KOMMUNINVEST
To begin the process of becoming a member of Kommuninvest, municipalities submit a notification of interest. This does not cost anything and it does not represent a commitment on the part of the municipality. While it is in the best interest of the applicant for the notification of interest to be issued by the governing body, the application process does not involve a formal resolution by the municipality.
Upon receiving the notification of interest, Kommuninvest conducts a thorough analysis of the municipality's finances. Both the municipality and any companies controlled by the municipality must demonstrate that their finances are sound. The analysis is based on five criteria: liquidity, financial flexibility, financial capacity, commitments, and external factors.
The results of the analysis are submitted to Kommuninvest's Credit Research Committee for consideration. The committee is comprised of chief executive officers and chief financial officers of member municipalities, as well as senior executives of companies owned by ' members. If the Credit Research Committee recommends approval, the application is then submitted to the Kommuninvest Board, which decides whether or not to make an offer of membership.
If the municipality decides to accept the offer of membership, its governing body must pass four resolutions:
1. The municipality shall accept the offer of membership in Kommuninvest.
2. The municipality agrees to pay the required amount of participation capital.
3. The municipality signs joint and several guarantees as for its own liabilities (surety agreement) for all obligations that Kommuninvest has entered into or will enter into.
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