While it is a first in Israel, the Ra'anana municipality has now joined an impressive list of North American and European cities that have issued a general obligation (GO) municipal bond to finance major projects.
Ra'anana mayor Nahum Hofree has announced that the city plans to issue NIS 170 million of GO bonds that will reach maturity in 15 years.
"For the first time, an Israeli city will be raising money exactly as if it were a corporation," he said. "We are the only city in Israel that, for the past 11 years, has finished the year in [the black]," said Hofree, adding that for the past five years Ra'anana has had a significant surplus on its annual balance sheet.
Municipal bonds are essentially IOUs issued by city governments to raise money for community projects. General obligation bonds represent a promise by the issuing municipality to levy enough taxes - or, in this case, collect enough project development fees - to make timely and complete repayments to investors.
A GO bond is backed by the city's ability to tax and the subsequent tax revenues it receives. This does not mean that taxes will rise, rather that the city has that option to raise money through taxes if the bond defaults for some reason.
The bond will be financed by Leader & Co. and Leumi & Co., which will sell bond units to institutional investors. The money raised will be used to fund infrastructure improvements such as streets, parks and libraries. Some will be invested in educational, sports and entertainment facilities in the city. General improvements to the main street and other neglected roads, a new high school for religious boys and new kindergartens are on the city's investment list.
"In the last three years, Ra'anana has spent NIS 150 million on development activities, such as repairs and maintenance for roads, sewage systems, water lines, and schools - NIS 75 million of that was loaned money," explained Amir Bartov, director of finance for the city. While NIS 74 million of the new bond has been tagged to finance city projects, NIS 95 million will be used to repay outstanding bank loans, at a lower interest rate.
Because GO bonds are secured by the city's ability to tax, most investors consider them relatively safe. However, they should be aware of all the risk and tax implications. Like all fixed income securities, the value of municipal bonds is susceptible to fluctuations in interest rates. If interest rates rise, bond prices will decline, despite the lack of change in both the actual coupon and maturity.
Until recently the Ministry of Finance did not allow Israeli cities to have municipal bonds. The only way they could raise money was through bank loans. In the past, banks helped individual cities, only to find the cities using the money irresponsibly and defaulting on their loans.
A year ago, the situation reached a crisis point where many local governments did not have enough to pay employee salaries. The Knesset passed a law opening a special account for those municipalities to use for the purpose of paying salaries. As a result, the banks were bypassed and ultimately cut off financing for all cities.
The Finance Ministry then agreed to open the money-lending market to allow other financial organizations such as insurance companies and pension companies to participate.
"We are the first city to offer a GO bond, which means we open ourselves to being audited by Ma'alot [Israel's credit rating agency]," Bartov explained. Ra'anana has a strong reputation as a financially solvent city, which is what led the agency to give the city an AA bond rating. The bond rating measures a city's ability to repay its debt.
For a city with such an impressive financial record, why issue a municipal bond? Why not just pay for the things you want or need with the surplus funds?
By offering a bond, the mayor says, the city will have the funds it needs immediately available to complete key projects rather than having to wait to implement them over a decade.
"We want to do things more quickly so residents will benefit more quickly," he said.
Most of the capital projects are scheduled for completion by the end of 2006.
Considering its record, it seems unlikely that Ra'anana will default on the bond. "Ra'anana is growing," said Hofree.
He also announced that hi-tech companies SAP and Converse will soon begin major expansions in the city's industrial area. SAP is building an 8,000 square meter facility and will hire 1,000 employees, while Converse is planning to create 5,000 hi-tech jobs.
Depending on the success of Ra'anana's initiative, other Israeli cities are expected to follow suit.
However, municipal opposition leaders Haim Broyde and Leah Halprin object to Hofree's plans to issue municipal bonds, claiming it will bankrupt the city. Zman Hasharon reported last week that in response to the mayor's announcement, the two sent him a letter stating their position. "Not only will the bond issue not reduce the city's debt burden, but it will increase it by NIS 85 million to NIS 275 million, which would bring the city to economic bankruptcyâ€¦ "
In principle, the two agree that the idea is a good one because it has the potential to provide the city with a broader base of funding, but they believe this step is being taken hastily. They further claimed that Ra'anana's supposedly balanced budget is a fiction because every time a deficit was created, the city took out another bank loan.
Additional reporting by Shoshana Michael-Zucker