Future of municipal infrastructure development finance

It recently came to light that there is a concern among some credit analysts and part of the investor community about the Development bank of Southern Africa’s (DBSA) exposure to financially unsustainable municipalities. Given the status of financial markets and bilateral relations for the bank to issue paper and conclude lines of credit, it is very important to contextualise the bank’s relationship with municipalities and the strategic response to prevalent challenges in the municipal market. This will assist investors in making more informed decisions based on comprehensive information beyond the bank’s published financial metrics.

The facts are that the DBSA has a long-standing history of supporting local government (used interchangeably with municipalities). In fact, the bank was founded four decades ago on the very principle of supporting local economies. The bank currently has a book exposure of about a third to municipalities as a percentage of its loan book, with a market share of local government finance of around 40%. This market share is realised from only banking a third of the total 257 municipalities. The Auditor General (AG) revealed in her recent consolidated general report on local government that the estimated expenditure budget for local government stood at R539 billion, as shown in Table 1. The table also presents the bank’s exposure split of its local government portfolio and the split sizes follow roughly the local government expenditure budget allocation patterns.

The main municipal infrastructure financing activities undertaken by the bank are in the energy, transport, water and digital infrastructure categories. The bank also accepts social infrastructure development mandates from national and provincial government departments, including government-owned entities in both spheres. The DBSA has made significant inroads in contributing to the development impact at municipality level over time. In the past 10 years alone, financial and non-financial infrastructure development support amounting to R70 billion has been deployed. This has facilitated some 84 600 jobs, creating household income of R22,5 billion. Funding support disbursed for infrastructure master plans, project preparation, revenue enhancement, asset care and township establishment amounted to R366 million over this period. The value of infrastructure unlocked for implementation in underdeveloped municipalities amounted to R8.2 billion.

The bank’s non-performing loan (NPL) policy requires that the gross NPL ratio be maintained between 6-9%. The municipalities portfolio’s NPL as a ratio of the municipal book is well below 2% or totally negligible as a ratio of the bank’s total loan book. As a matter of standard operating procedure, the bank hardly ever writes off any non-performing municipal debt. Instead, non-performing businesses are supported by the bank’s business recovery unit to assist municipalities get back on their feet. Over and above ongoing client consultations, standard and rapid portfolio reviews are undertaken as and when necessary to keep on top of developments.

The municipal space is a very difficult market. The AG noted in the 2022/23 consolidated general report on national and provincial audit outcomes that 68% of infrastructure projects are delayed and 47% of them had exceeded their budgets. The DBSA has over the past few decades acquired specialised skills and experience to deal with municipal credit challenges, including recent operational issues caused by municipal coalition governments. The bank is the only financial institution that has this kind of in-depth experience on the municipal market.

Through its intimate interaction with municipalities, the bank understands that:

• Municipalities are facing rising climate change-related disasters (like the floods we saw last year in KwaZulu-Natal and the Eastern Cape).
• Municipalities are facing declining economic growth trends.
• Municipalities are facing declining credit quality – caused mainly by the weakening economic growth trends, and capacity and governance issues. This, in turn, weakens municipalities’ revenue collection rates and increases their dependency on the national fiscus, instead of their own revenue generation capabilities. Capacity and governance constraints make it difficult for municipalities to make a meaningful economic turnaround. The same constraints make it very hard for municipalities to respond swiftly and adequately to the rising climate change-related disasters.
• Municipalities’ operations are also hindered by political interference and funds misappropriation.

The municipal exposure concern is, therefore, not so much about the bank’s skill, mettle or experience in the local government market. It is really about how the bank will navigate the municipal space in the future, given that the outcomes of the national elections next year might exacerbate the challenges faced by municipalities. The answer to this question lies in the bank’s local government strategy as described below. The strategy is deployed in line with the bank’s credit extension process, which ensures an overall balance between financial stability and development impact.

Since all infrastructure development projects take place at municipality level, it is important to ensure that municipalities are functional. Before 2022, the bank focused on increasing lending to municipalities on high impact development projects and programmes. At that time, the focus was on lending and non-lending support to achieve strong overall development impact. However, it was realised that municipal support should be much more than just financing and a bit of non-lending support – municipal support should be comprehensive and responsive to challenges faced by municipalities.

The DBSA has now adopted an Integrated Municipal Approach as the strategy to be pursued on municipalities. This approach seeks to, among others:

• Partner and support specific district spaces instead of single municipalities
• Utilise the DBSA development subsidy to enable the Infrastructure Delivery Division of the bank to unlock municipal projects
• Implement frontloading of municipal grants by financing development project and programmes upfront
• Pursue project finance type opportunities, e.g., embedded energy generation investments

The Integrated Municipal Approach is implemented through the Partner-A-District platform, which aims to achieve four strategic development areas to:

• Invest in critical infrastructure (using frontloading, among other instruments)
• Deliver and manage infrastructure (through the Infrastructure Delivery Division)
• Strengthen governance and the institutional architecture of municipalities (through partnerships)
• Support local economic development (through partnerships and using our Development Laboratories, which are physical precincts set up in townships and rural areas to address socio-economic challenges to break the intergenerational cycle of poverty, inequality and unemployment)

Thus far, the bank has identified 8 willing districts from five of our nine provinces as the initial partners. The partnership is approached from a full infrastructure development value chain angle that involves project planning, preparation, financing, building and maintenance. The intention this time around is to work with these districts over a number of years, to ensure that the required development impact is achieved.

One of the basic requirements for South Africa to progress economically is that municipalities must be fit for purpose and deliver relevant services to communities. The future of local government might not always be crystal clear, but by understanding the operating environment and correctly interpreting strategy scenarios, the institution has a very good handle of the market. Municipal exposures are well managed. Admittedly, and like in any other investment environment, there will always be challenges, but the DBSA has the relevant determination and experience to support its municipality infrastructure investment decisions.

Zeph Nhleko is the chief economist at the Development bank of Southern Africa.