GÖRLICH: 'Buy a house from debt and pay while living there'
He has been one of the key players in Krak-w's plan to issue zl. 45 million ($18 million) in municipal bonds. Earlier this month, the city picked three banks to lead manage the placement of the issue's first zl. 15 million ($6 million). Jilting foreign institutions like Creditanstalt and ING Bank, the city chose three Polish banks: Bank Wsp-lpracy Regionalnej, Bank Przemyslowo-Handlowy and Pekao SA. The Polish banks offered to place the bonds at the same price as 52-week treasury bills. This left others in the industry howling that the bond issue wasn't a bond issue at all. Rather, it was a dressed-up bank loan, they said. GŻrlich defends the city's choice of a lead manager, saying it chose the banks because they offered the cheapest price. GŻrlich, who holds a Ph.D. in geochemistry, discussed Krak-w's approach to Poland's municipal bond market with the WBJ's Michael Rey. The following is an edited version of their conversation.
Q: Several cities across Poland are in the midst of muni bond issues. How is Krak-w approaching its first issue?
A: We've been planning it for a year and a half. This may be different from other cities, which went to find a banking partner to do the issue for them. We have tried to identify various markets, various legal and institutional ways to issue bonds and on a more permanent basis. We planned a tender to find not only a lead entity at the best price, but one that will insure that they have good distribution of the bonds and that this distribution is, if not public, on the broadest possible customer base. Also, the issuing group has to work with us on developing various types of issues for various purposes in order to maintain the lowest capital costs. We decided to first run a pilot issue, small but big enough to be attractive with the perspective that we will carry out other issues in 1996. We wanted to focus on the content of the proposals. Tenderers were asked to show their institutional arrangements, legal arrangements, legal systems and the ways how they structure costs for this issue and possibly more.
Q: Why did you chose the consortium over Creditanstalt and ING Bank, which have experience in municipal bond issues?
A: We've chosen the Polish consortium with two banks that are based in Krak-w. The primary reason was they were the cheapest price. They offered us a rate discounted over the next five years, the maturity of the bond, at a level of 20.5% over costs. This compared to 21.5% of the other banks. The other thing was that they would keep the terms of this issue over the other issues that we want to do this year.
Q: What would those issues be used for?
A: This is all for capital improvements. We are rebuilding one of the main crossroads here for zl. 9 million ($3.6 million). The first issue, the remaining zl. 6 million ($2.4 million), will go to the Krak-w transportation center. The next issues would go towards continuation in investments in the transportation center, reconstruction of the road system and opening 20 hectares for commercial investment. We try not to use the money from debt to finance our current expenditures. I really want to avoid the situation where money is available and now people think we can improve living standards.
Q: With cities seeing bond issues as a cheap source of cash, do you think there will be a problem with cities like Krak-w over leveraging themselves?
A: We see the bad examples in western cities. We know there is a trap. We have a partner city with Frankfurt and this city has problems because of the local recession. They have sustained a large debt and had problems paying it back. We know all those things. Before we decided to take this loan, we prepared a five-year plan with a 15-year projection, to see that we don't go higher in debt service than 20% of our overall revenues. We don't want to reduce the level of spending on current costs. There are things that we designed so that people won't think we are increasing investment beyond the level where it starts to eat money from everyday expenditures.
Q: What changes had to be made in the thinking of the Krak-w city government for debt financing to gain approval?
A: It took us about a year to discuss. There was big opposition. People were afraid because they saw the effect of debt, the debt of the federal government taken on in the seventies. This example was used extensively throughout the whole debate. We told them that the really efficient financing for construction is usually through debt. You can have the delayed payment and other ways of paying for things that are already operating. Something that was very convincing to people was the example that you can save your money for 30 years and buy a house, or you can buy a house from debt and pay while living there. We also have created an agency of city development. It will focus on credit financing and debt control and the design of our capital improvement budget. It is a device that does not exist in any other city in Poland, but we have specially made it just parallel to what we are doing with debt. We know that city hall has no experience. The way of dealing with financing was always very simple here. So that is why we've created the agency.
Q: So you are planning more debt?
A: We do plan more debt. The expertise in the agency would help us, on the one hand, to design our investment programs and financing programs. On the other hand, it will help the other development agencies that we have created, like the joint-stock company created to develop the transportation project. We wanted to have an intermediary between the projects that we are doing with public money.
Q: Are there other municipalities approaching you for advice on how to design a local development agency?
A: A lot. In fact we will open a branch of the Warsaw Municipal Development Agency. Because of what we are doing in the programming of investment and financing, they wanted to set up a branch. They will monitor our budget in order to try to use it as an example for elsewhere in Poland. We have had a lot of cities approaching us about the bond issue. For instance, our price was so low that the next week, when Gdansk was just concluding their own tender, we told them how low a price it should be. They gained at least 1% on their price.
Q: How will the Krak-w bonds compete with similarly priced government T-bills. Analysts suggest that Krak-w bonds are more of an investment risk. They don't have the guarantee of the federal government.
A: I think that in fact, the city has, mentally, the same rating as the state. We have surveyed the question of whether to get a rating or not. We were advised that as long as we stayed on the domestic market, we would probably do harm to ourselves if we started with a rating now.
Q: Why is that?
A: The ways of rating cities in Poland is very complex. If you go to Moody's or Standard & Poor's, that have little experience of doing that in our country, it may be a risky thing. We may get something that would not improve our quality. Instinctively, people treat the city as a very reliable thing. When you show our finances, the fact is that we have no debt. We have stability and economic growth and real liquidity on the necessary level. In fact, what we heard from people who were bidding here, including big banks like ING, they were saying that we need a rating. I asked how they estimated the size of the market, because we were interested if the prices we were getting were because of excess liquidity in the banks. They were all saying that Krak-w should not worry because the market does not differentiate now. People are buying T-bills of course, but also there is a market still for a little more risk at the same price. There is enough market for buying anything like that. The price seems attractive for people. I know that most loans are going now below 20%. It means that on the money market, it is not that easy that the benchmark of the 52-week T-bills will stay a good reference. We are calculating the rate from the past year, which means that as the curve is going down you will have the capital much cheaper than it realistically is. It is still attractive for people to do that. The bank will find buyers for this. This is one of our conditions. They have to demonstrate that they sold. We do not want to see that they just bought it, which is also nice, but one of our terms was that they will sell it.
Q: If the consortium buys the issue itself, wouldn't that constitute a failed issue and doom the city to a poor investment rating?
A: Definitely. The next zl. 30 million will go to the market as widely as possible because we will see what happens now with the zl. 15 million and we will make conclusions. We were not willing to sell it to ING, which offered a higher interest on it, which also has, in fact, the same investor base. This is not the difference. At this price everybody will buy. We wanted to check that this is really a market value for this. If we went for ING, we would have gotten the same information as Gdynia, that at this price everyone is buying. They were not willing to reduce anything like what they've done. I think that based on what we knew (the consortium) was cheaper. We see that as long as we have a written confirmation (they will sell it). We know the banks could easily buy it for themselves. But they have signed the condition that they will sell it. If we don't see that, they lose because we have started to prepare the issue of zl. 30 million and they will not get it if they don't demonstrate that they redistributed this one.
Q: Has the city considered selling on foreign bond markets?
A: We are not really thinking of the international market yet. The reason is that the domestic market is enough. All the experts are saying we should really see that the domestic market is holding acceptable rates for us, and then try to go abroad. What I see now is that zloty-denominated paper is available in London. The zloty is attractive now because of the exchange rate. We could be trying to use this opportunity to do a lot of interesting things. But there is a lot of risk that this will change. We have to look at it as a process where we are bringing the paper to the market, but also which is bringing people in a democratic process to understand what we are doing with public money. It's the first time. They have never seen such obligations or gone so far. We have never made a debt other than preferential loans from the environmental bank, which people treat as something acceptable. So, I see we have to do those steps and we are now so far successful. The city council approved the issue, then they approved the new budget with a deficit of about zl. 55 million ($22 million) this year. I think it's the only legal budget passed by a Polish city which has this much written-in debt. Warsaw wants to make debt, but it is not part of the budget.
Q: What needs to be done on the federal level to make this easier for Krak-w and other cities?
A: Nothing has been done. There is big competition from federal bonds, which have tax breaks and incentives we don't have. Everybody is buying the state's bonds, not as a long-term investment, but as a tax write-off. In this sense, the government is competing with us for capital on the market. I don't think it is fair. We talked about it on various levels with the Securities Commission, Mr. Socha and formerly Mr. Paga. Before the market for municipal bonds is up and running there will be no decisions. I hope we will have tax exemptions for specific types of projects, or we will have the situation which puts us on the same level as the state bonds. The same thing happens with income tax for our municipal services. They are paying a 40% tax. It is not fair because we are all doing public jobs, like building roads, which the state is doing from those taxes, while they are telling us to do the same thing after taxes. I treat this as a whole package. We hope there will be no tax on municipal companies and also there will be at least the same conditions for the bonds. Either they will be tax exempt, or at least the state bonds will not have the tax break.
Q: Are there any indications from the federal government when this might happen?
A: It may happen any year because it can be written either into the federal tax law or the annual budget passed by the parliament. We've done a lot in terms of political talking about it. I think that it is still an issue for us. The law on bonds needs to introduce the definition of what is a municipal bond. Now there is the definition that a municipal bond is a debt issued by a municipality. I think a better definition is that it is a bond which has a tax exemption and where the money is used for public purchases with descriptions of what types of purchases. This makes it easier for the legislature to make it tax exempt because then they can say for which category of municipal bonds there is a tax exemption, for other bonds issued by the city, for a commercial center for example, like revenue bonds of various types. This idea was not successful. The current law still says that a municipal bond is a bond issued by a municipality. It doesn't give any practical definition for anything. But I hope it will happen. It doesn't mean this definition cannot come in the new tax law.
Q: How will a city like Krak-w compete in a domestic, municipal bond market that could become saturated?
A: This year there will be several cities, maybe up to zl. 1 billion ($400 million), on the market. I think that with the preparations we are doing, understanding the mechanisms and having an overview of the proposed partners, we now have a potential access to the European markets. Also, the requirement we have for the broadest possible investor base will show us that although over-liquidity in the banks is a problem, they will probably try to get rid of the money that they have.
Q: Several cities across Poland are in the midst of muni bond issues. How is Krak-w approaching its first issue?
A: We've been planning it for a year and a half. This may be different from other cities, which went to find a banking partner to do the issue for them. We have tried to identify various markets, various legal and institutional ways to issue bonds and on a more permanent basis. We planned a tender to find not only a lead entity at the best price, but one that will insure that they have good distribution of the bonds and that this distribution is, if not public, on the broadest possible customer base. Also, the issuing group has to work with us on developing various types of issues for various purposes in order to maintain the lowest capital costs. We decided to first run a pilot issue, small but big enough to be attractive with the perspective that we will carry out other issues in 1996. We wanted to focus on the content of the proposals. Tenderers were asked to show their institutional arrangements, legal arrangements, legal systems and the ways how they structure costs for this issue and possibly more.
Q: Why did you chose the consortium over Creditanstalt and ING Bank, which have experience in municipal bond issues?
A: We've chosen the Polish consortium with two banks that are based in Krak-w. The primary reason was they were the cheapest price. They offered us a rate discounted over the next five years, the maturity of the bond, at a level of 20.5% over costs. This compared to 21.5% of the other banks. The other thing was that they would keep the terms of this issue over the other issues that we want to do this year.
Q: What would those issues be used for?
A: This is all for capital improvements. We are rebuilding one of the main crossroads here for zl. 9 million ($3.6 million). The first issue, the remaining zl. 6 million ($2.4 million), will go to the Krak-w transportation center. The next issues would go towards continuation in investments in the transportation center, reconstruction of the road system and opening 20 hectares for commercial investment. We try not to use the money from debt to finance our current expenditures. I really want to avoid the situation where money is available and now people think we can improve living standards.
Q: With cities seeing bond issues as a cheap source of cash, do you think there will be a problem with cities like Krak-w over leveraging themselves?
A: We see the bad examples in western cities. We know there is a trap. We have a partner city with Frankfurt and this city has problems because of the local recession. They have sustained a large debt and had problems paying it back. We know all those things. Before we decided to take this loan, we prepared a five-year plan with a 15-year projection, to see that we don't go higher in debt service than 20% of our overall revenues. We don't want to reduce the level of spending on current costs. There are things that we designed so that people won't think we are increasing investment beyond the level where it starts to eat money from everyday expenditures.
Q: What changes had to be made in the thinking of the Krak-w city government for debt financing to gain approval?
A: It took us about a year to discuss. There was big opposition. People were afraid because they saw the effect of debt, the debt of the federal government taken on in the seventies. This example was used extensively throughout the whole debate. We told them that the really efficient financing for construction is usually through debt. You can have the delayed payment and other ways of paying for things that are already operating. Something that was very convincing to people was the example that you can save your money for 30 years and buy a house, or you can buy a house from debt and pay while living there. We also have created an agency of city development. It will focus on credit financing and debt control and the design of our capital improvement budget. It is a device that does not exist in any other city in Poland, but we have specially made it just parallel to what we are doing with debt. We know that city hall has no experience. The way of dealing with financing was always very simple here. So that is why we've created the agency.
Q: So you are planning more debt?
A: We do plan more debt. The expertise in the agency would help us, on the one hand, to design our investment programs and financing programs. On the other hand, it will help the other development agencies that we have created, like the joint-stock company created to develop the transportation project. We wanted to have an intermediary between the projects that we are doing with public money.
Q: Are there other municipalities approaching you for advice on how to design a local development agency?
A: A lot. In fact we will open a branch of the Warsaw Municipal Development Agency. Because of what we are doing in the programming of investment and financing, they wanted to set up a branch. They will monitor our budget in order to try to use it as an example for elsewhere in Poland. We have had a lot of cities approaching us about the bond issue. For instance, our price was so low that the next week, when Gdansk was just concluding their own tender, we told them how low a price it should be. They gained at least 1% on their price.
Q: How will the Krak-w bonds compete with similarly priced government T-bills. Analysts suggest that Krak-w bonds are more of an investment risk. They don't have the guarantee of the federal government.
A: I think that in fact, the city has, mentally, the same rating as the state. We have surveyed the question of whether to get a rating or not. We were advised that as long as we stayed on the domestic market, we would probably do harm to ourselves if we started with a rating now.
Q: Why is that?
A: The ways of rating cities in Poland is very complex. If you go to Moody's or Standard & Poor's, that have little experience of doing that in our country, it may be a risky thing. We may get something that would not improve our quality. Instinctively, people treat the city as a very reliable thing. When you show our finances, the fact is that we have no debt. We have stability and economic growth and real liquidity on the necessary level. In fact, what we heard from people who were bidding here, including big banks like ING, they were saying that we need a rating. I asked how they estimated the size of the market, because we were interested if the prices we were getting were because of excess liquidity in the banks. They were all saying that Krak-w should not worry because the market does not differentiate now. People are buying T-bills of course, but also there is a market still for a little more risk at the same price. There is enough market for buying anything like that. The price seems attractive for people. I know that most loans are going now below 20%. It means that on the money market, it is not that easy that the benchmark of the 52-week T-bills will stay a good reference. We are calculating the rate from the past year, which means that as the curve is going down you will have the capital much cheaper than it realistically is. It is still attractive for people to do that. The bank will find buyers for this. This is one of our conditions. They have to demonstrate that they sold. We do not want to see that they just bought it, which is also nice, but one of our terms was that they will sell it.
Q: If the consortium buys the issue itself, wouldn't that constitute a failed issue and doom the city to a poor investment rating?
A: Definitely. The next zl. 30 million will go to the market as widely as possible because we will see what happens now with the zl. 15 million and we will make conclusions. We were not willing to sell it to ING, which offered a higher interest on it, which also has, in fact, the same investor base. This is not the difference. At this price everybody will buy. We wanted to check that this is really a market value for this. If we went for ING, we would have gotten the same information as Gdynia, that at this price everyone is buying. They were not willing to reduce anything like what they've done. I think that based on what we knew (the consortium) was cheaper. We see that as long as we have a written confirmation (they will sell it). We know the banks could easily buy it for themselves. But they have signed the condition that they will sell it. If we don't see that, they lose because we have started to prepare the issue of zl. 30 million and they will not get it if they don't demonstrate that they redistributed this one.
Q: Has the city considered selling on foreign bond markets?
A: We are not really thinking of the international market yet. The reason is that the domestic market is enough. All the experts are saying we should really see that the domestic market is holding acceptable rates for us, and then try to go abroad. What I see now is that zloty-denominated paper is available in London. The zloty is attractive now because of the exchange rate. We could be trying to use this opportunity to do a lot of interesting things. But there is a lot of risk that this will change. We have to look at it as a process where we are bringing the paper to the market, but also which is bringing people in a democratic process to understand what we are doing with public money. It's the first time. They have never seen such obligations or gone so far. We have never made a debt other than preferential loans from the environmental bank, which people treat as something acceptable. So, I see we have to do those steps and we are now so far successful. The city council approved the issue, then they approved the new budget with a deficit of about zl. 55 million ($22 million) this year. I think it's the only legal budget passed by a Polish city which has this much written-in debt. Warsaw wants to make debt, but it is not part of the budget.
Q: What needs to be done on the federal level to make this easier for Krak-w and other cities?
A: Nothing has been done. There is big competition from federal bonds, which have tax breaks and incentives we don't have. Everybody is buying the state's bonds, not as a long-term investment, but as a tax write-off. In this sense, the government is competing with us for capital on the market. I don't think it is fair. We talked about it on various levels with the Securities Commission, Mr. Socha and formerly Mr. Paga. Before the market for municipal bonds is up and running there will be no decisions. I hope we will have tax exemptions for specific types of projects, or we will have the situation which puts us on the same level as the state bonds. The same thing happens with income tax for our municipal services. They are paying a 40% tax. It is not fair because we are all doing public jobs, like building roads, which the state is doing from those taxes, while they are telling us to do the same thing after taxes. I treat this as a whole package. We hope there will be no tax on municipal companies and also there will be at least the same conditions for the bonds. Either they will be tax exempt, or at least the state bonds will not have the tax break.
Q: Are there any indications from the federal government when this might happen?
A: It may happen any year because it can be written either into the federal tax law or the annual budget passed by the parliament. We've done a lot in terms of political talking about it. I think that it is still an issue for us. The law on bonds needs to introduce the definition of what is a municipal bond. Now there is the definition that a municipal bond is a debt issued by a municipality. I think a better definition is that it is a bond which has a tax exemption and where the money is used for public purchases with descriptions of what types of purchases. This makes it easier for the legislature to make it tax exempt because then they can say for which category of municipal bonds there is a tax exemption, for other bonds issued by the city, for a commercial center for example, like revenue bonds of various types. This idea was not successful. The current law still says that a municipal bond is a bond issued by a municipality. It doesn't give any practical definition for anything. But I hope it will happen. It doesn't mean this definition cannot come in the new tax law.
Q: How will a city like Krak-w compete in a domestic, municipal bond market that could become saturated?
A: This year there will be several cities, maybe up to zl. 1 billion ($400 million), on the market. I think that with the preparations we are doing, understanding the mechanisms and having an overview of the proposed partners, we now have a potential access to the European markets. Also, the requirement we have for the broadest possible investor base will show us that although over-liquidity in the banks is a problem, they will probably try to get rid of the money that they have.
