The City of Cape Town is to pursue the option of issuing its own municipal bonds as an alternative source of capital funding. In so doing, it will be only the second municipality in the country to explore this option. In 2004, the City of Johannesburg was the first to issue publicly listed bonds.
The Finance Portfolio Committee has now asked the City's Treasury Department to initiate a process to establish a five year Domestic Medium Term Note (DMTN) programme which will lead to the eventual issue of City of Cape Town municipal bonds.
According to Cllr Ian Neilson, Mayoral Committee Member for Finance, the City's current external borrowings of R2,3 billion are sourced mainly from the commercial banking sector and the Development Bank of SA.
"The City's decision to diversify its funding sources by accessing the South African bond market was prompted by several factors. Loan agreement conditions are becoming more stringent, the pool of lenders in the R500 million+ category is extremely limited, and forecasted growth in infrastructural spending is expected to exhaust lending capacity for the municipal sector in the traditional borrowing market.
"The establishment of a five year DMTN programme would provide the City with a cost-effective funding mechanism, and the flexibility to issue municipal bonds at short notice to meet its funding requirements," says Cllr Neilson.
Preliminary investigations indicate that an initial bond issue by the City of Cape Town in the range of between R500 million and R1 billion over a maximum maturity of 10 years would be well received by the capital market.
According to Lodi Venter, City Treasury Director, the municipality's medium-term expenditure framework (MTEF) indicates a total borrowing requirement of about R5,7 billion over the next five years.
This is based on inflation-adjusted capital expenditure of R1,3 billion for 2006/07, R882 million for 2007/08, R824 million per annum thereafter, and the current borrowing backlog of R700 million.
South Africa's debt capital market, which is regulated by the Bond xchange of South Africa (BESA), has over 500 debt instruments with a current market capitalization of R620 billion. The RSA Government accounts for 70% of the listed debt, while the municipal sector is represented only by the City of Johannesburg.
"Cape Town's access to this well developed market would greatly expand its borrowing options, reduce its average cost of borrowings, and enhance its profile in financial markets," says Cllr Neilson.
Between 2004 and 2006, the City of Johannesburg (COJ) issued four bonds totalling R3.9 billion. It has also established a five year DMTN programme to facilitate the issue of further bonds of up to R6 billion.
"The COJ bonds were well received by the capital market and are currently trading at a spread of 1% above the corresponding RSA bonds. The City of Cape Town is perceived to be a better credit risk than Johannesburg and should improve on the Johannesburg spreads," says Mr Venter.
Just last week, the City scored credit ratings of AA- in terms of its financial capacity to repay long term liabilities, and A1+ in terms of short term obligations.
"The once off costs in establishing a DMTN programme and issuing a bond of R1 billion are estimated at between R2.5 million and R3 million. These costs can be paid for out of savings achieved through a reduction in the rate of interest payable.
"The City's average cost of borrowing is currently 11.4%. A bond issue would have a major impact in reducing these costs. Just a 0.4% reduction in interest rates applicable to a R500 million loan equates to an annual saving of R2 million alone," says Mr Venter.
City Treasury will now prepare a detailed roll-out plan and budget for approval by the Mayoral Committee.