What is a loan?
A loan is the lending of money to a party (borrower) coupled with the obligation that the loan amount (principal) plus interest will be repaid at a future date.
Loans by the Government can be put into 2 categories:
- Government Commercial loans - The terms and conditions are comparable to the private market. A market assessment should be undertaken to understand what terms the commercial market is willing to lend on.
- Government Concessional loans - The terms and conditions are more favourable than those offered by private debt markets. The concessional finance toolkit provides further information on the types of concessional debt terms and conditions as well as the appropriateness of concessional financing mechanisms.
When should I use a Government commercial loan?
There are a number of considerations to be balanced in determining the most appropriate non-grant financing options (or blend of options). Generally, Government financing should be a last resort.
Loans are generally appropriate where the borrower has a history (or reasonable expectation) of generating reliable positive cash flows sufficient to make loan repayments and pay interest. 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. Loans are generally lower risk, lower return than equity investments.
Commercial loans from Government can be used to bridge a commercial finance market gap. An example where government (or quasi-government) commercial loans could be used is where the volume of private finance required is more than that available at the time the project is needed or finance is not available upfront (until a de-risking of certain upfront risks has occurred). Commercial loans should generally not be used if private finance at similar terms is available and might be crowded out.
The concessional loans toolkit provides guidance when considering concessional loans as a financing option.
Characteristics of Government commercial loans
| Characteristic | Details |
|---|---|
Ability to influence financed objective Medium | The terms and conditions of loans can be negotiated to influence the outcome that government is seeking. For example, limiting the use of funds to specified projects and releasing funds gradually once milestones have been met. |
Level of market intervention Medium | The use of loans can enable companies to navigate challenging periods (i.e., start-ups or market disruption/creation). There is a risk of crowding out private finance as a project progresses. This risk should be assessed over time, with exit strategies considered to withdraw Commonwealth support when it is no longer necessary. |
Commercial discipline incentive Medium-High | Loans encourage commercial discipline through loan terms where there is a known repayment period and interest requirement. This encourages companies to monitor and appropriately manage income and expenses to meet repayments. |
Certainty of financial return High | Loans provide certainty with a known repayment period and interest requirement. The certainty of financial return will depend on the creditworthiness and ability of the borrower to repay. |
Opportunity to realise upside gain Nil | Unlike equity, a loan does not benefit from upside risk, with the financial return limited to interest received. |
Level of financial risk Medium | 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. In addition, lenders rank ahead of equity providers in the event that the borrower becomes insolvent. Loans may also be secured (see below). |
Security of asset High | Loans may be secured over particular assets (including shares of the borrower entity), which can allow for some funds to be recouped in the event the borrower is unable to meet the required repayments. Security over assets is only beneficial where the underlying assets are valuable. |
Administration costs Medium | Medium administration costs for the Commonwealth in establishing governance arrangements for the loan agreement. More complex arrangements will typically incur higher administration costs. |
Accounting and budget classification and reporting of loans
Accounting standards classify loans as financial assets. In order to provide a loan, there must be some probability of repayment. In addition to Annual Reporting requirements in accordance with the relevant accounting standards, loans over $200 million are subject to additional disclosure requirements in the Statement of Risks in Budget Paper 1 – Budget Strategy and Outlook. More information on recognition in Budget aggregates is available here.
Implementing loans
This section provides guidance on implementing Commonwealth loans (including commercial and concessional loans).
A key step to implement a loan decision is to develop a fit-for-purpose loan agreement.
A loan agreement is a detailed record of a loan between the borrower (proponent) and the government (lender), including details about loan repayment and obligations of both parties.
Loan implementation checklist
Entities should consider the following prior to implementing a loan:
- Is a loan the most appropriate financing mechanism to achieve government’s objectives?
- If appropriate, are there private parties willing to provide financing/how much financing are involved from parties providing?
- Assessment of confidence around:
- Project/program development and operational costs
- Operational revenues to repay principal and interest
- Commonwealth return.
- What are the risk levers that will inform key loan terms, including:
- What is the creditworthiness of the borrower or parent? Do they have a credit rating? Is a parent company guarantee desirable?
- What is the loan being used for?
- What market risks are associated with the investment?
- What level of oversight and reporting is appropriate for the project or resultant asset? Does a loan achieve appropriate oversight?
Loan agreement considerations
Where appropriate, entities should consider appointing expert advisors when establishing complex loan structures to assist in appropriately managing risk. Entities should ensure the following considerations are addressed to develop and deliver a loan agreement:
- Principal amount and drawdown schedule
- Is the principal amount consistent with the project that is being funded?
- How are principal repayments schedules structured and is there an appropriate plan to ensure final repayments?
- What milestones/conditions precedent are appropriate before drawdowns are made?
- Repayment schedule, including due dates and whether the loan is repaid over the life or at maturity. For loans repaid over the life of a project, frequency of repayment should also be considered.
- The appropriate interest rate for the loan
- What interest rates are being offered on comparable loans in private markets (if any)? What level of concessional is appropriate (if any)? If the interest rate is set below the market rate, it will be considered as a concessional loan.
- Is a fixed or floating/variable rate more appropriate?
- How should interest be charged and when should interest be paid?
- Should the interest rate increase or decrease during the life of the loan, and if so, under what conditions?
- How does the security of the loan rank relative to any other borrowings?
- If subordinated, should this influence the appropriate interest rate?
- What are the consequences should the borrower fail to make a scheduled repayment or miss an interest payment?
- What recourse or security should there be?
- Would it be appropriate to use one or more covenants?
- Is a related or parent entity guaranteeing repayment?
- Is there security over an asset and has the asset been valued? How does the value of the asset compare to the total value of the loan?
- What should the lock-up triggers and events of default be?
Ongoing management of loans
Commonwealth loans are commonly managed through Specialist Investment Vehicles (SIVs). However, where loans are provided directly by Departments, processes should be established to ensure appropriate ongoing management. Entities are likely to need to assign oversight of the loan to a particular team/function and ensure that all reporting and other information requirements in the loan documentation are fulfilled by the loan recipients. Entities should be completely satisfied that milestones for conditions precedent are achieved and appropriately documented before releasing drawdowns. If not, further information should be sought before additional financing is provided.
If loan requirements are not met or other events take place which are covered by the loan agreement it is the responsibility of the Entity to manage the investment. This should include but is not limited to legal advice on the loan specifics or commercial advice on the implications of aspects of the loan agreement not being met.
