Attachment 6.2.1: Treatment of guarantees

The Commonwealth provides a $1 billion loan guarantee in June 2013 (that has only a 5 per cent chance of being called). The impact on the estimates and projections included in the 2013-14 Budget would be as follows (for both cash and accrual).

Current treatment
2013-14 Budget

Proposed treatment
2013-14 Budget

Guarantee
($m)

2013-14

2014-15

2015-16

2016-17

Total

Agency

0

0

0

0

0

The guarantee does not impact on the underlying cash or fiscal balances.

Under the current treatment of guarantees, the risk is not appropriately priced. This creates poor incentives for ministerial decision making as:

  • there is no impact on the ‘bottom line’ (UCB);
  • there is no requirement for the proposing minister to offset the cost, like grant expenditure; and
  • there is no incentive to charge the beneficiary for the risk taken on by the Commonwealth.

Guarantee
($m)

2013-14

2014-15

2015-16

2016-17

Total

Contingency reserve
(assumed expected costs)

0

-50

-50

-50

-150

*Expected cost of the guarantee is calculated as $1b with 5% chance of default ($1b x %5 = $50m per year).

The expected cost of the guarantee is accounted for in the Contingency Reserve to reflect the risk of a call on the guarantee. The expected default costs worsen the underlying cash and fiscal balances over the forward estimates.

Under the proposed treatment, the risk is appropriately priced. This creates better incentives for ministerial decision making as:

  • there is an impact on the ‘bottom line’ (UCB); and
  • there is a requirement for the proposing minister to offset the cost, or preferably charge the beneficiary for the risk taken on by the Commonwealth.

By the 2014-15 Final Budget Outcome, provision in the Contingency Reserve is backed out, if the guarantee was not called upon.

Current treatment
2014-15 Final Budget Outcome


Guarantee
($m)

2014-15

Agency

0

There is no change to the impact in 2014-15.

Proposed treatment
2014-15 Final Budget Outcome


Guarantee
($m)

2014-15

Contingency reserve

0

No costs are recorded for the agency in that year.

 

By the 2015-16 MYEFO, the expected costs in 2015-16 and 2016-17 have increased.

Current treatment
2015-16 MYEFO


Guarantee
($m)

2013-14

2014-15

2015-16

2016-17

Total

Agency

0

0

0

0

0

There is no change to the impact across all the years.

Proposed treatment
2015-16 MYEFO


Guarantee
($m)

2013-14

2014-15

2015-16

2016-17

Total

Contingency reserve

0

0

-70

-70

-140

The expected costs for 2015-16 and 2016-17 are revised upwards which worsen estimates of the underlying cash and fiscal balances for those years.

By the 2015-16 Final Budget Outcome the Commonwealth had to pay $800m on the guarantee (net of recoveries) in 2015-16 and nothing in 2016-17.

Current treatment
Actuals


Guarantee
($m)

2013-14

2014-15

2015-16

2016-17

Total

Agency

0

0

-800

0

-800


The payment is recorded in 2015-16 worsening the underlying cash and fiscal balances.

Proposed treatment
Actuals


Guarantee
($m)

2013-14

2014-15

2015-16

2016-17

Total

Contingency reserve

0

0

0

0

0

Agency

0

0

-800

0

-800

The amounts in the Contingency Reserve would be removed and the actual payment (net of recoveries) would be allocated to the agency. The payment amount worsens the underlying cash and fiscal balances.

 

Attachment 6.2.1: Treatment of loans (at market rate or concessional)

In June 2013 the Commonwealth provides a $1 billion loan for 10 years at a concessional rate of 5 per cent. The market borrowing rate for the entity is 11 per cent and the government borrowing rate is 4 per cent. The Commonwealth expects to lose 10 per cent or $100 million through loan default costs. The impact on the estimates and projections included in the 2013-14 Budget would be as follows.

Cash treatment
2013-14 Budget – Underlying cash balance

Accrual treatment
2013-14 Budget – Fiscal balance

Loan
($m)

2013-14

2014-15

2015-16

2016-17

Total

Interest receipts
less public debt interest

0

10

11

12

33

Upfront grant

-100

0

0

0

-100


Expected interest receipts progressively improve the underlying cash balance, while public debt interest costs progressively worsen the underlying cash balance.

Where it is expected at the origination of a loan (or loan programme) that the loan will not be repaid in full, a grant component, equal to the expected non-repayment, is recognised as a payment.

Loan
($m)

2013-14

2014-15

2015-16

2016-17

Total

Interest receipts
less public debt interest

0

10

11

12

33

Present value of interest discount and unwinding of discount

-224

35

33

31

-125

Upfront grant

-100

0

0

0

-100

Expected interest receipts progressively improve the fiscal balance, while public debt interest costs progressively worsen the fiscal balance.
The fiscal balance immediately reflects the present value of the interest discount over the life of the loan (worsening the fiscal balance upfront). This does not capture the economic or default cost of the concessional loan, only the value of interest that the Commonwealth gives up for which it is not compensated. This discount is unwound over the term of the loan (improving the fiscal balance) in anticipation of the full repayment of the loan principal.
Where it is expected at the origination of a loan (or loan programme) that the loan will not be repaid in full a grant component, equal to the expected non-repayment, is recognised as an expense.