Financing Municipalities and relevance of Credit Rating the Indian experience

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Financing Municipalities and relevance of Credit
Rating - the Indian experience

• International Conference on Financing
  Muncipalities and Sub-National Governments,
  Washington
• October 1, 2004

Roopa Kudva
Executive Director Chief Rating Officer,
CRISIL Limited, India
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Presentation flow

• Introduction to CRISIL
• Credit Rating Definition
• Urban Infrastructure in India A snapshot
• Benefits of Credit Rating of Urban Local bodies
• CRISIL Ratings for borrowing programmes of Urban
  Local bodies
• Credit enhancement mechanisms and illustration
• Conclusion

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About CRISIL

• First and the largest credit rating agency in
  India
• 4th Largest Rating Agency in the World
• Affiliation with Standard Poors (USA)
• The first to rate a state government in India
  Gujarat
• The first municipal bond rating in Asia
  Ahmedabad
• Credit assessment of all the major state
  governments and more than 100 urban local bodies
  in the country. This also includes
• 5 municipal corporations
• 2 Water and Sewerage Service providers

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What is Credit Rating?

• Credit Rating is an opinion on the relative
  degree of safety regarding debt obligations being
  met on time.
• It is an opinion, not a recommendation
• Relative degree of safety vis-a-vis other debt
  instruments
• Timeliness is key
• Instrument-specific could be different for a
  structured instrument and stand-alone
• Assigned by a committee of experts in finance,
  management economics, after a detailed and
  in-depth discussion

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CRISILs Rating Scale
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Current status of urban infrastructure

• Current availability of urban infrastructure is
  inadequate
• Most of the ULBs do not meet the WHO water supply
  (140 LPCD) and sewerage services norms (80 of
  the water supplied)
• Solid waste management services need
  modernization
• Though roads are mostly available their quality
  is poor

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Current status of urban infrastructure
Sharply growing urban population is putting
pressure on already stretched urban
infrastructure
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Capital Expenditure Requirement

• Estimates of capex on urban civic services show
  significant expenditure requirements

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Sources to fund urban infrastructure

• Fund and non-fund based support from the state
  government
• Capital grants
• Direct project specific loans
• Support to borrowing programmes through
  guarantee
• Project specific/reform oriented assistance from
  the central government
• Mega city scheme
• City Challenge fund
• National slum development programmes
• Projects to be under taken in accordance with the
  planning commission recommendation
• Internal sources

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Growing importance of market borrowing

• Pressure on funding sources
• Traditionally, most projects have been funded
  through state government support. However, this
  source is declining
• Strained fiscal position, results in lowering of
  fund based support
• Mounting guarantee levels limit the non fund
  based support
• Abolition of octroi has impacted buoyancy in the
  revenues
• This necessitates the use of market borrowing for
  funding the urban infrastructure projects.
• Credit rating is vital for market borrowing

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Credit Rating of Urban Local Bodies Benefits

• Use of market borrowings to bridge gap in
  critical infrastructure can accelerate economic
  growth in the service area
• Increased accessibility to funds from the capital
  markets
• Improved visibility - facilitates flow of
  international capital
• Potential for creation of a municipal bonds market

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Credit Rating of Urban Local Bodies Benefits

• Helps benchmarking with other urban local bodies
• Municipal corporations like Ahmedabad, Nashik
  Thane have used market borrowings to part fund
  their projects
• Helps in monitoring overall debt level finances
• Provides investors an independent and unbiased
  evaluation of credit quality
• Helps investors in pricing the debt offer

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CRISIL ratings for Urban Local Bodies
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CRISIL rating methodology for Urban Local Bodies

• CRISILs Rating Methodology involves an in-depth
  assessment of the following factors
• Legal and Administrative framework
• Economic base of the service area.
• Municipal finances
• Existing operations of the municipal body
• Managerial Assessment
• Project specific issues
• Credit Enhancement Structure

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Need for credit enhancement

• Relatively low standalone credit quality of most
  local bodies/water boards necessitates
  credit enhancement.
• Rating can be enhanced to a target rating through
  credit enhancement mechanisms.

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Credit enhancement alternatives

• Escrowing of dedicated revenue streams
• Full guarantee from an entity with superior
  credit profile
• Partial guarantee mechanism
• Pledging of cash collateral
• Partial amount guarantee
• Partial tenor guarantee
• Partial interest guarantee
• Pool financing

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Rating approach to structured Bonds

• Full guarantee Rating of the guarantor
• Cash Collateral Coverage of debt and stand
  alone rating
• Partial guarantee Credit view on issuing entity
  and guarantor
• Escrow structures / Interception grants
• Separately identifiable cash flow stream
• Quality and sustainability of the cash flow
  stream
• Pool Financing
• Smaller Urban local bodies aggregating to raise
  funds
• Useful for Urban local bodies with weaker credit
  profile as pooling leads to diversification of
  Risk

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Pool Financing
ULB 1
SPV
  INVESTORS
Legend Structured Bonds Issue Proceeds Bonds Subs
criptions Subsequent Repayments
ULB 10
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Pool Financing (cont.)

• Advantages
• Diversification of risk
• Structuring possible to enhance credit quality
• Optimum use of credit enhancement
• Credit enhancement by multilaterals or Government

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Rating approach for pool financing

• Credit analysis of the pool of assets (Urban
  local bodies)
• Cash flow analysis
• Sizing credit enhancement
• Payment structure analysis
• Legal analysis

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Illustrations of credit enhanced ratings

• Nashik Municipal Corporation
• Size of the bond programme USD 22 mn
• Salient features of the credit enhancement
• Escrow of Octroi receivable
• No lien period commence from 360 and 180 days
  prior to the principal and interest payment
  respectively
• Monthly annuity payment
• Rating Assigned AA(So)

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Illustrations of credit enhanced ratings

• Chennai Metropolitan Water and
  Sewerage Board
• Size of the bond programme USD 22 mn
• Salient features of the credit enhancement
• Escrow of water charges receivable
• No lien period commence from 360 and 180 days
  prior to the principal and interest payment
  respectively
• Monthly annuity payment
• Rating Assigned AA(So)

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Illustrations of credit enhanced ratings

• A group of 116 ULBs (a pool financing case)
• Size of the bond programme USD 22 mn
• Salient features of the credit enhancement
• State government guarantee 35
• Cash collateral 35.9
• Bond would be floated by a SPV
• Target Rating A (so)

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Conclusion

• Significant need for capital expenditure
• Growing population has intensified the need to
  improve the existing services
• Limited funding support from traditional sources
• Already high level of state government guarantees
• The relatively low credit quality of many state
  governments restricts any meaningful credit
  enhancement
• Increasing use of market borrowing as a funding
  option

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Conclusion

• Most of the ULBs borrowing programme would
  necessarily require a credit enhancement due to
  their weak credit profiles
• Market discipline will have a beneficial impact
  on the reforming ULBs systems and process
• User charges would be rationalized to attain
  project viability

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Thank You
Contact Details Phone [phone]
Fax [phone] www.crisil.com
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Annexure CRISILs criteria for rating urban
local bodies1. Legal Administrative Framework

• Municipal functional domain as defined by the
  relevant act
• Decision making process
• State government transfers
• Tax rates basis of assessment
• Borrowing powers ability to pledge revenues
• State government municipal linkages

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2. Economic Base of the Service Area

• Population base and growth rate
• Level of industrial and commercial activity
• Diversity and elasticity of tax base
• Per capita income levels
• Prospects for widening of tax base

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3. Municipal Finances

• Accounting quality
• Overall surplus/deficit on revenue account
• Profile and trends in tax and non tax revenues
• Property tax effort Demand raised, rates,
  systems, coll. eff.
• Dependence on SG transfers Stability
  transparency
• Expenditure profile Head wise activity wise
• Capital receipts and expenditures - Trends
• Debt profile Cost, tenure, coverage
• Future sources of revenue growth
• Measures to curtail revenue expenditure

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4. Existing Operations

• Range of services obligatory/discretionary
  functions.
• Core services Water, sewerage facilities,
  primary education health, etc.
• Systems in place for delivery of these services
• Level and trend of past expenditure on these
  services.
• Proposed level of service enhancement
• Major projects undertaken

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5. Managerial Assessment

• Linkage between financial health initiatives
  taken by a proactive management.
• Organizational structure
• Administrative systems and procedures
• Project management skills
• Level of control on expenditure
• Initiatives taken to enhance resources and
  improve collection mechanisms

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6. Project Details

• Proposed projects
• Project tenure and funding patterns
• Debt servicing requirements due to new projects
• Existing level of service improvements
  envisaged