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Sub-national pooled financing: Lessons from the United States

Kirti Devi's picture

As infrastructure projects are increasingly decentralized to sub-national governments (SNGs) in many countries, policymakers are keenly interested in developing sub-national bond markets to open up access to private-sector financing. However, the transaction costs of bond issuance are still prohibitive for small SNGs.
 
Pooled financing—through regional infrastructure funds, municipal funds, or bond banks—is being explored as a solution. Yet, many questions remain: 
The just-released working paper: Municipal Pooled Financing of Infrastructure in the United States: Experience and Lessons, supported by the Public-Private Infrastructure Advisory Facility's (PPIAF) Sub-National Technical Assistance Program (SNTA), addresses these questions and provides a review of the state bond banks in the United States , which since the 1970s have become a cost-effective and stable model for expanding sub-national financing for many small municipalities, while maintaining strong credit ratings with virtually no defaults from sub-borrowers.

In the state of Maine, for example, the municipal bond bank has issued 1,814 loans to 517 government units. The bond bank has also been successful in lowering financing costs for small, unrated government agencies, with the median size loan from 2012 to 2016 being $842,000 and the smallest loan only $30,000.

It is important to note that the United States has a well-developed sub-national capital market, with an average of $359 billion worth of bonds issued annually from 2013 to 2016. Also, the necessary regulatory framework for the sub-national capital market evolved over a long period beginning with state constitutional reforms setting debt limits (1840s), use of bond counsel (late 1800s), revenue bond instrument (late 1800s), and the development of Chapter 9 of the Bankruptcy Code (1937). This was accompanied by various institutional developments such as U.S. Securities and Exchange Commission oversight, accounting reforms, credit ratings, regulations of bond dealers, disclosure of financial statements, etc.
 
Each U.S. state has its own independent framework for its bond bank, however most have common features, including:
  • Independent, self-supporting institutions established by the state.
  • Permission to issue tax-exempt bonds for public-purpose capital projects.
  • Public status means bond banks do not need to earn a profit or pay taxes.
  • No state guarantee (bond bank debt therefore does not contribute to state debt limits).
  • No taxation power.
Credit pooling benefits issuers by spreading administrative costs across a number of participating entities. The portfolio’s geographic diversification and the use of credit enhancements can improve credit ratings. Primary security for pooled bonds are local government’s timely loan repayments, which are backed by the local government’s general obligation or revenue obligation.
 
Bond banks can also have additional layers of security, including: separate accounts for loan repayment held by a trustee, debt service reserve funds, authority to intercept state aid payments to local governments in case of default.
 
The SNTA-supported report also discusses broader lessons for developing countries that are interested in establishing pooled financing for sub-national infrastructure.

Findings were presented at a World Bank seminar in May, chaired by Carole Brookins, former U.S. Executive Director to the World Bank, which generated wide interest across the Bank’s Global Practices.

For more information about the SNTA program and funding, visit our website.

Representatives from the World Bank’s Global Practices discuss lessons from the U.S. bond bank model at a joint event organized by the World Bank’s Governance Practice and PPIAF’s Sub-National Technical Assistance Program (SNTA) in May 2017. Pictured from left to right: François Bergere, PPIAF Program Manager; Carole L. Brookins, Managing Director of Public Capital Advisors LLC; Lili Liu, Global Lead: Decentralization and Intergovernmental Relations, Governance; Michael De Angelis, Regulatory and Legal Framework Senior Adviser; Sally M. Torbert, Public Sector Consultant.


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Comments

Submitted by Dr. Mohamed Taher Abdelrazik Hamada,Ph.D on

Pooled financing for subnational infrastructure through the American financial
institutions that can enhance development in the developing countries .
Once again the World Bank developed issues that can figure the USA Bond Bank Model
based on decentralization and intergovernmental relations , which can show that consultation and putting framework policy are among the jobs of the borrowers financial institutio.
This poilcy enhances the role of the private sectors in line with the public sectors in the developing countries.
One can say that pooled financing needs long term investment and allowing investors to have a long period at the site of investment that maybe a minimum of fifteen yearsto to make sure that the money allocation is put in the right direction .
One can argue that small municipalities can not apply to pooled financing .
Pooled financing is very applicable to infrastructure that are based on PPPS system.
Yours Very Respectfully,
Dr. Mohamed Taher Abdelrazik Hamada, Ph.D
Retired Professor at Strayer University, USA
Address
[redacted]

Submitted by Mike Moriarty on

I am uncertain how the big question of loan repayment would work.

Surely, like any finance instrument, if you raise $600m for public infrastructure, you will need to amortize the debt over a defined period. Surely then, the only benefits here are certainty of finance provision and perhaps lower interest rates. Or am I missing something? Please advise

Submitted by ADRABO ALOYSIUS STANLEY on

Thank you for this insight and experience. In many developing countries, Financial discipline and honouring pledges and commitments, is still a challenge for both local authorities and regional governments, in part due to competing demands, or open abuse. The relations between National, and regional or sub national governments , also play a role. The default rates among local governments, or failure by National governments to meet their obligations in time are some of the lingering challenges to date. Financial Institutions have to be supervised vigorously, the private sector supported and the control of National governments over local governments, by way of oversight made predictable. The elements of Trust , obligations, capacity to contribute funds to joint ventures and execute projects, require a careful balance and consideration, given that Many of the actors are fragile. Strong political support will be required, clear communication and co-ordination frameworks put in place. Humble, step by step, progressive and case by case approach should yield positive results. Note that not all the actors will have the patience and time to wait for results.

Submitted by Brien Desilets on

It is refreshing to see the World Bank recognize US leadership in subnational finance but this report barely scratches the surface. As indicated, the bond banks reviewed have only about $10 billion in bonds outstanding in a market of nearly $4 trillion. Bond banks are in fact a minor feature of the US muni market. More interesting is the fact that approximately 2/3 of all bonds in the market are revenue bonds that are not backed by government balance sheets but by dedicated revenues (i.e. project finance bonds). Another related feature is the existence of independent authorities such as water authorities and transportation authorities that issue their own bonds that are once again not backed by government balance sheets. Of course, authorities and local governments have the legal mandate to raise revenues against which they can bond. There are many more best practices and lessons learned from the US that can benefit developing country subnational capital markets.

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