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Financing Municipalities and Relevance of Credit Rating - The Indian Experience

This document summarizes a presentation given by Roopa Kudva of CRISIL Limited on credit ratings for municipalities and sub-national governments in India. It provides an overview of CRISIL, the largest credit rating agency in India, and discusses the benefits of credit ratings for urban local bodies and municipalities seeking to access market borrowing. Credit ratings are important for municipalities as traditional funding sources are declining and market borrowing is increasing. However, most local bodies have weak standalone credit quality requiring credit enhancements like escrow accounts or guarantees to obtain investment-grade ratings. The presentation provides examples of CRISIL's ratings on municipal bond programs with different credit enhancement structures.

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0% found this document useful (0 votes)

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Financing Municipalities and Relevance of Credit Rating - The Indian Experience

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Akshat Singhal

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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
CRISIL Limited

Executive Director & Chief Rating Officer,

CRISIL Limited, India

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

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

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

CRISILs Rating Scale

Rating Sym bol AAA AA A BBB BB B C D Definition Highest Safety High Safety Adequate Safety Moderate Safety Inadequate Safety High Risk Substantial Risk Default Speculative Grades

Investm ent Grades

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

Current status of urban infrastructure

Sharply growing urban population is putting pressure on already stretched urban infrastructure:

Census Year

1971 (actual) 1981 (actual) 1991 (actual) 2001 (actual) 2011 (projected)

Rural Population (millions) 439.05 523.86 628.69 741.66 801.77

CAGR Urban Population CAGR (millions) 109.11 159.46 217.61 285.34 377.12

1.98% 2.05% 1.85% 0.87%

4.32% 3.51% 3.06% 3.15%

Total Population (millions) 548.16 683.32 846.3 1027.02 1178.89

Rural: Urban 80:20 77:23 74:26 72:28 68:32

Source: Census of India 2001 and 1991

Capital Expenditure Requirement

Estimates of capex on urban civic services show significant expenditure requirements
Resource Services/Infrastructure covered by Period of requirement Source the report recommendation ($ billion) India Infrastructure Report, Various urban infrastructure 1996 (Rakesh Mohan Capital costs as well as operational 2000-2005 27 Committee) and maintenance needs Zakaria Committee Norms Water supply, sewerage/sewage (1963) updated to 1997-98 disposal, storm water drainage, construction of roads & paths, street lighting & electricity distribution operations and Ministry of Urban maintenance. Revenue gap for operation & Development and poverty maintenance requirements relating Alleviation to civic services

2000-2005

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

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

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

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

CRISIL ratings for Urban Local Bodies

Amount rated (USD mn) Ratings Outstanding 22 22+22+22 22+11 22 27.8 11 156 AA+(so) AA (so) AA(so) AA (so) A+(so) AA (so) A

Corporation Name Municipal Corporation of Hyderabad Ahmedabad Municipal Corporation Nasik Municipal Corporation Thane Municipal Corporation Bangalore City Corporation Chennai Metro Water Supply and Sewarage Boards Hyderabad Metro Water Supply and Sewarage Boards

Type

Form of credit enhancement Cash collateral and Escrow of Municipal corporation various municipal taxes Property Tax Escrow, Octroi Municipal corporation Escrow Property Tax Escrow, Octroi Municipal corporation Escrow Municipal corporation Octroi Collections Property tax collections + State Municipal corporation government guarantee Service provider Service provider Escrow of water charges

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

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.

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

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

Pool Financing
ULB 1

SPV
Legend ULB 10

INVESTORS

Structured Bonds Issue Proceeds Bonds Subscriptions Subsequent Repayments

Pool Financing (cont.)

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

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

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)

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)

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)

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

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

Thank You

CRISIL Limited

Contact Details: Phone: +91 (22) 5691 3001- 09 Fax: +91 (22) 5691 3000 www.crisil.com

Annexure: CRISILs criteria for rating urban local bodies 1. 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

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

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

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

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

6. Project Details
Proposed projects Project tenure and funding patterns Debt servicing requirements due to new projects