This Toolkit item relates to Part 2 - Investment Governance, Funding and Financing of the Commonwealth Investments Resource Management Guide.
What are concessional loans?
Concessional loans are on the Commonwealth’s balance sheet with terms and conditions that are more favourable than loans made available in the private market. Concessional loans have a real opportunity cost. The concessional terms may be one or more of the following:
- below market expected returns from the financing (for example, interest rate)
- accepting potentially higher risk than what the market would accept when providing debt
- funding that is being committed, or provided, over a longer period than what is available in the market
- structure of repayments and the length of the financing (for example, grace periods, subordination, income-contingency repayments and longer tenors)
- the inclusion of bespoke terms and conditions that are ‘non-market standard’ for the expected risk.
How are concessional loans provided?
The Commonwealth has established several Specialist Investment Vehicles (SIVs) to provide loans along with other forms of financing where there is a market gap and the ability to crowd-in private sector investment (for example, the National Reconstruction Fund Corporation, Export Finance Australia and the Clean Energy Finance Corporation). Often, financing is provided on concessional terms, in line with the SIV’s Investment Mandate/statement of expectations. Further information about SIVs is available on the Department of Finance’s website.
Regardless of whether SIVs are able to consider the proposal the Australian Government can consider providing concessional loans, where there is constitutional head of power, legislative authority and policy authority for consideration on the Commonwealth’s balance sheet. Entities should contact InvestmentFramework@finance.gov.au as early as possible if they are developing a balance sheet New Policy Proposal to provide direct concessional financing.
When to use concessional loans
All commercial financing options (including government delivered commercial financing) should be tested before considering concessional financing. Entities should first consider the desired policy objectives, the responsibilities of SIVs and undertake a 3 Step Commercial Assessment to ensure concessional financing is the most appropriate option to achieve the government’s policy objectives. Concessional financing is commonly considered when addressing a market gap where there are financing risks that the private sector is unwilling to take on, or to de-risk projects to support the crowding in of private investment. When considering appropriate terms and conditions, the level of concession(s) provided should be no more than commensurate with the anticipated benefits. The level of concession(s) should be the minimum level necessary to allow the proposal to proceed and achieve the desired outcomes. This may include providing a split deal, which includes a package of concessional and commercial financing.
Generally, concessional loans are used to support policy objectives where repayment of the Commonwealth’s funding plus an appropriate amount of interest is expected. There must be a reasonable expectation of return on, and of, capital. Concessional loans would typically be provided for limited, defined, policy linked purposes (for example, to contribute towards funding a particular project) and not be made available for general corporate purposes, particularly if the corporate has many activities not linked to the policy objectives. Entities should consider why commercial or SIV financing is not available (for example, bank debt) and consider what concessions are appropriate to achieve the government’s desired policy outcomes, while protecting the Commonwealth from unnecessary risk and encouraging commercial discipline. See further guidance on considering, implementing and ongoing management of loans, including an implementation checklist, in the Loan toolkit.
Where a project cannot service a concessional loan with an interest rate that is above but close to the Commonwealth’s cost of borrowing plus the cost of administering the loan, other funding mechanisms (such as a grant or splitting into a grant and loan arrangement) should be explored.
While drawing down and repaying principal does not impact on the Commonwealth’s underlying cash balance and net debt, it does affect headline cash and gross debt aggregates. The fair value of the concessional loan impacts on the Commonwealth’s fiscal balance. Further guidance on accounting for concessional loans is available in the Finance Advice Paper - Q&A – Concessional Loans and the Resource Management Guide No. 115 – Accounting for Concessional Loans.
Considerations for using concessional loans
| Consideration | Concessional loans |
|---|---|
| Objectives |
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| Threshold minimum concession |
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Revenue and cash flow projections Further guidance in Financial Modelling Toolkit |
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| Timeframe |
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Capital Structure *Contact InvestmentFramework@finance.gov.au for further guidance on assessing capital structure. |
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| Possible levers for concession |
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Characteristics of concessional loans
| Characteristic | Concessional loans |
|---|---|
| Ability to influence financed objective | Depends on the loan terms, as the level of influence may be limited to or by specific loan conditions. |
| Level of market intervention | The use of loans can enable navigation of challenging periods (i.e. start-ups or market disruption/creation). There is the potential for crowding out private finance as a project progresses. |
| Commercial discipline incentive | Loans encourage commercial discipline through loan terms where there is a known repayment period and interest requirement. |
| Certainty of financial return | Loans provide certainty with a known repayment period and interest requirement. To provide a loan, there must be a reasonable probability of repayment. |
| Opportunity to realise upside gain | A loan does not benefit from upside risk, with the upside limited to interest received. It is possible to include loan terms that would see accelerated payback or sweep of principal in the event of greater/earlier than expected financial performance of the borrower. |
| Level of financial risk | Loans have a lower risk profile than equity, as loan obligations are paid as part of operational cash flows and prior to any distributions to equity and may be secured. The risk of default may be higher under a concessional loan, making the level of financial risk higher for loans with a higher level of concession. |
| Security of asset | Lenders rank ahead of equity holders if the borrower is insolvent. Loans may be secured over assets (including shares of the borrower entity). This is only beneficial where the assets are valuable. Non-recourse loans offer less security than recourse loans. Non-recourse loans are only secured by the collateral (for example, physical assets) offered by the borrower with no financial guarantee. Full recourse loans are secured by all of the lender’s assets. Subordinated debt offers less security over assets than senior/secured debt. |
| Administration costs | Medium administration costs for the Commonwealth in establishing governance arrangements for the loan agreement and oversight throughout. There should be due diligence and a robust financial model before implementing. |
Accounting and budget classification and reporting of concessional financing
A concessional loan’s fair value is less than the nominal value of the loan due to the loan’s terms and conditions being more favourable than could be obtained from a commercial provider. The difference between the nominal amount and the fair value of the loan is the concessional component. The concessional component worsens net debt (as the loan is valued at less than the amount lent) and is classified as an expense, worsening net operating balance and fiscal balance. As it does not involve a non‑reciprocal cash payment a concessional loan does not affect the Underlying Cash Balance.
RMG 117 has further information on accounting for concessional loans. Entities should engage with Finance early to discuss accounting treatment and budget implications for concessional loans.
