Guidelines on Local Government Borrowing and Recent Developments in South East Europe
3. Which debt instrument is suitable?

3.3. Municipal Bonds

Local governments can obtain long term funds, by issuing municipal bonds on domestic or international capital markets.

A bond is an interest bearing certificate issued by an organization in order to borrow money. A bond is a debt-agreement between the borrower or issuer, and the lender or investor. The issuer usually pays on borrowed funds a fixed (pre-determined) periodic interest (coupon). Principal repayment can occur either in one tranche at maturity (bullet) or in multiple tranches throughout the life of the bond (e.g. linear amortization or progressively increasing or decreasing amortization).

Local government bond issues are intermediated by investment and/or commercial banks in case of private placements or by brokerage houses in case of public placement. One advantage of bond issues over bank loans is that they may open local government 43 access to longer term funds. Also the repayment schedule of a bond can be more attractive (e.g. bullet bonds).

One of the main arguments in favor of municipal bonds is that they can accommodate longer maturities than bank loans. Also, the costs of borrowed funds by issuing bonds is usually lower than the cost of a long-term loan. However, issuing a bond is more complicated than taking a loan and requires a more developed financial market.

Types of municipal bonds

General obligation bonds

The type of bond, which the local governments choose to issue, depends upon the benefit the investment produces. If the investment generates a facility or service that benefits the entire or at least a bigger part of the local community, the investment is said to be a "public good," and should be paid for by all taxpayers. Thus a general obligation bond is appropriate. Typical examples of these investments include: public safety, streets and bridges, public parks and open space, as well as public buildings. General obligation bonds are secured by the local governments' revenues stream.

Table 7: Example of Local Government Bonds Issue in Croatia

Local Government Issuance date Maturity (years) Currency Amount (EUR) Coupon rate) Purpose
Koprivnica 2004 7 HRK 8.000.000 6.5% Communal infrastructure and sport facilities
Zadar 2004 7 HRK 18.500.000 5.5% Sport hall building with swimming pool
Split 2006 7 EUR 4.000.000 4.562% Cultural and athletic facilities and communal infrastructure
Zagreb 2007 10 EUR 300.000.000 5.5% projects within Zagreb Holding
Vinkovci 2007 10 HRK 5.600.000 5.5% Culturalbusiness center with swimming pool
Osijek 2007 10 HRK 3.333.333 5.5% Revitalization of the city square
Split 2007 8 EUR 8.100.000 4.75% Various capital projects
Split 2008 7 EUR 8.200.000 6% Various capital projects

The case of Croatia is very interesting for analysis purposes. Significant progress of local government bond market development happened since 2004. All bonds that have been issued by local governments are general obligation bonds which are secured only by local government's budget.

Prior to the bond issuance, the Croatian Securities and Exchange Commission defined disclosure standards for securities. These standards define the type of information of the investment projects and the financial standing of the issuer, that the issuer must present in the bond prospectus (sale document) but also periodically once the bond has been sold.

Revenue bonds

Often referred to as "limited liability" bonds, these rely solely upon a city's pledge of restricted revenues or user fees (such as service charges, tolls, admission fees, leases 45 and rents) to guarantee repayment. Revenues that back the repayment are usually generated by the project which is financed from such bonds. Revenue bonds are not backed by the taxing power of the local government. Failure to raise sufficient revenues to make payments will result in default of the revenue bonds. In some limited situations, local governments have backed revenue bonds with a tax pledge to add strength to the creditworthiness of the revenue bond. These are referred to as "tax-supported revenue bonds" or "indirect general obligation bonds." This approach may work when the revenues are not strong or where there is a limited credit history associated with the project. Rating of revenue bonds may differ from creditworthiness of the city and is strongly dependent on the cash-flows generated by the project but also on other factors (e.g. willingness and capacity of a municipality to provide financial support in case of default).

Capital investments that directly benefit a specific group of users that pay for the investment through user charges are considered to be a "private" good, and appropriate for revenue bond financing. Examples include: municipally-owned airports, water and sewer systems, electric utilities, athletic and sport facilities and limited access highways.



Eurobonds are international bonds denominated in a currency different from that of the country in which they were issued (so not only in EUR). Eurobonds are tradable and transferable securities, as defined in the EU Prospectus Directive (89/298). Eurobonds are usually launched through a public offering and are listed on a stock exchange.

City of Bucharest on its municipal €500M Eurobond issue- the largest Eurobond offering

by a regional or local entity in CEE and the first Romanian municipal Eurobond. The Eurobond issue launched by the Bucharest City Hall in June 2005 on the London market was fully underwritten, to EUR 500M, with a 4.277% annual interest rate. The interest to be paid by the municipality is approx. one per cent lower than the one paid for Romania's latest Eurobond issue.

The bonds have ten-year maturity, and the bond issue was brokered by investment banks ABN Amro and JP Morgan.

The funds are used to finance infrastructure projects such as the Basarab overpass, acquisition of public transportation means (buses and trams), rehabilitation of streets and tramlines.