CRISIL Limited Financing Municipalities and relevance of Credit Rating - the Indian experience International Conference on Financing Muncipalities and Sub-National Governments, Washington October 1, 2004 Executive Director & Chief Rating Officer, Roopa Kudva CRISIL Limited, India

2 Presentation flow Ü Introduction to CRISIL Ü Credit Rating : Definition Ü Urban Infrastructure in India – A snapshot Ü Benefits of Credit Rating of Urban Local bodies Ü CRISIL Ratings for borrowing programmes of Urban Local bodies Ü Credit enhancement mechanisms and illustration Ü Conclusion

3 About CRISIL First and the largest credit rating agency in India 4 th 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

4 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

5 CRISILs Rating Scale

6 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

7 Current status of urban infrastructure Sharply growing urban population is putting pressure on already stretched urban infrastructure:

8 Estimates of capex on urban civic services show significant expenditure requirements Capital Expenditure Requirement

9 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 Sources to fund urban infrastructure

10 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 Growing importance of market borrowing

11 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

12 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 Credit Rating of Urban Local Bodies– Benefits

13 CRISIL ratings for Urban Local Bodies

14 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 CRISIL rating methodology for Urban Local Bodies

15 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.

16 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

17 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

18 Pool Financing SPV INVESTORS ULB 1 ULB 10 Legend Structured Bonds Issue Proceeds Bonds Subscriptions Subsequent Repayments

19 Pool Financing (cont.) Advantages Diversification of risk Structuring possible to enhance credit quality Optimum use of credit enhancement Credit enhancement by multilaterals or Government

20 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

21 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)

22 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)

23 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)

24 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

25 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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27 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

28 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

29 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

30 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

31 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

32 6. Project Details Proposed projects Project tenure and funding patterns Debt servicing requirements due to new projects Existing level of service & improvements envisaged