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Municipalities in the interest rate trap…

Municipalities in the interest rate trap … or paradise …

Interest rates are on a historic low. Whether all municipalities will benefit from the current negative interest rates, and if so and how, will be decided in the next few months by court. Nevertheless, Banks are still interested in doing business with municipalities, because it can be lucrative from the perspective of risk weigehted assets (RWA).

Grants exceed the interest rate charges…

Many credit projects also exist of promotions that often reflected in the form of subsidies for interest payments and have been fixed in the past for the entire funding period. For this reason, there could be excess income of these subsidized loans. These surplus currently represents a welcome additional income for municipalities that usually run in the budget and be used for general purposes. Taken into account that the duration of assistance may be shorter than the term of the loans and that interest also may rise.

 

Can interest rates also rise … and what interest rate parameter is cheaper …

Although it currently does not look in Europe, that interest rates may rise rapidly, at least at the short end of the yield curve, it is historically proven in any case, that interest rates may rise and fall. At least in the United States of America we might see this year still a rate hike.

 

… history tells floating… and professionals say fixed …

Historical studies show that it is driven probably cheaper in recent years with a floating interest rate. But did you also take into account, ie the interest rate risk? The management of such risks has suffered in the past. For managing risk you have to know the risks. Professional market participants, such as the Federal Financing Agency of the Republic of Austria (The Austrian Treasury) or her counterpart in the Federal Republic of Germany have provided the predominant majority of their debt with fixed interest rates. German municipalities have approximately 80% fixed interest rates.

Austrian municipalities have, in contrast, provided approx 75% of its debt at floating rates. This also leads to a significant reduction in current expenditures in municipal budget. But hand on heart, does your budget can afford an increase in the annual interest payments on 3% or a tripling of current interest payments?

 

Now what can to be done …

All these issues concern many roles in a municipality, officials as well as employees and are more complex.

  • Should I choose a floating or a fixed rate?
  • What is the interest rate risk?
  • Are there other risks?
  • What is operational risk?
  • Opt for a “Fixzinskredit” or interest rate swaps to hedge my interest rate risk?
  • What about the Municipal Code?
  • Are there any criminal aspects?
  • Do I have a continuous documentation?
  • What is your question?

 

Financial constitution – why it may help

In addition to a professional, independent, ongoing advice   a financial constitution can help to minimize risks. We see a loan portfolio similar to an investment portfolio. The following points are essential:

  • Understanding
  • Planing
  • Reacting
  • Checking

Under a financial constitution we understand a simple set of rules that ensures, inter alia, the following points:

 

  • voluntary self-limitation
  • initial analysis
  • ongoing monitoring
  • Structured reporting system

Also the political and operational responsibility should be defined. The preparation and periodic revision is made on the basis of current developments and economic information. Entered risks should be determined. The definition of general standards such as monitoring and reporting order round off the contents.

Also keep in mind that any control that is not documented, is no control …

About The Author

Heinz Hofstaetter
Over 20 years of international experience in senior management positions in the areas of consulting, banking, finance, asset management, valuation and Real Assets.