Johan Kruger, MD of Inca, says First National Bank took the initiative and sponsored Inca's formation.

"At the time, due to the volatility in the sector, local authorities had no access to the capital markets," Kruger says.

"People simply did not want to lend to this market as they did not have the expertise required to manage the risk and monitor their debtors on a continual basis.

"Furthermore, given the size of the municipal sector, it was simply not worthwhile for the large institutions to develop their own dedicated departments to cope with the challenges represented by the sector."

Inca placed itself between municipalities and the capital markets, bringing its expertise to bear and acting as the privatesector intermediary, developing specialised risk and credit assessment models.

In addition, Inca's staff began to build expertise in the publicsector lending environment, ensuring it was up-to-date with regulations and policy changes.

At that stage there were more than 840 municipalities, and while this has been reduced to 284, the process of amalgamation added to the volatility.

The key funding role performed by Inca is illustrated by the company's exposure to municipalities, which stands at about R4,7bn. About R550m has been repaid, Kruger says.

In other words, Inca has provided over R5bn in essential funding that has enabled municipalities to develop their infrastructure, he says.

"Most of the funds are used to provide infrastructure for the previously disadvantaged communities through their municipalities, resulting in a vast array of projects such as sewage, water and better roads; therefore Inca has been able to make a substantial contribution to improving the quality of life for South Africans," Kruger says.

Inca does not fund on a per- project basis, preferring to provide finance on a balance sheet lending basis. The loans are made for capital expenditure.

"Inca looks at the municipality, the risk, the balance sheet and the income, not at whether the individual projects are sustainable," Kruger says.

"We do not take project income as security."

The extremely low level of bad debt illustrates its success.

On Inca's present exposure of R4,7bn, the company has a default rate of R60000 in terms of interest payments in arrears.

"If municipal debtors are managed properly, they are not a bad risk. However, it is essential to ensure we have a hands-on management approach."

Kruger says SA's municipalities have been through a challenging period of rationalisation, merging smaller municipalities to create larger entities.

For instance, the metropolitan municipality of Ekurhuleni was formed by merging 11 separate administrations.

Kruger says that the scale of such mergers is massive and there are very few of comparable size and complexity in the private sector.

"Given the challenges the municipalities faced, it is a wonder that they managed to continue functioning during this period.

"SA will enjoy the benefits of this rationalisation process in the years ahead.

"Many of the smaller municipalities simply could not sustain the capacity they needed to deliver effective services to their communities.

"However, by merging there is more flexibility and they have the joint capacity to employ the appropriate skills and resources," Kruger says.

The amalgamation process did put municipal resources under strain and there was a resulting slowdown in development.

With this process largely concluded, Inca expects development to escalate significantly.

Inca has been a successful investment vehicle. Its shareholders have enjoyed dividend returns of more than 20% a year.

Institutional investors buying the bonds issued by Inca have realised a return of 1,1% above that of government bonds.

"Our investors, shareholders and our international lenders are happy that they are receiving a return that is in line with their risk and reward expectations," Kruger says.