CREDIT EVALAUATION AND RATING OF URBAN LOCAL BODIES ( ULBs) AND IMPLICATIONS FOR THE URBAN REFORM AGENDA

A PRESENTATION BY:

SUJATHA SRIKUMAR

SENIOR VICE PRESIDENT

IL&FS

ABOUT IL&FS Incorporated in 1987 with primary objectives of

– Commercialisation of infrastructure projects in India, and

– Offering comprehensive range of financial services to the infrastructure sector

Shareholders include :– HDFC, CBI, UTI (promoters), SBI – IFC (W), Orix Japan, Govt. of Singapore, Credit

Commercial de France Pioneer in infrastructure financing and project

development in India– project sponsor, developer, advisor, financier, operator

and manager for variety of infrastructure projects

Uniquely positioned to provide end-to-end project development

and financing solutions from conceptualization to

implementation in urban infrastructure sector

Financial advisors and investment bankers to first municipal

bond issue - Ahemdabad Municipal Bond Issue

Project Developer of first private sector water sector project

in the country- New Tirupur Area Development Corporation

ABOUT IL&FS

MUNICIPAL BONDS (MBs)

Concept of MBs as an additional mechanism for raising resources for urban infrastructure sector first presented at an USAID seminar in 1995

MBs have played a key role in the creation of urban infrastructure assets in United States and Canada

Later recommended for Commercialization of Urban Infrastructure in India by the Rakesh Mohan Committee

Would open new vistas for attracting private capital to the urban infrastructure sector

WHAT ARE MUNICIPAL BONDS

MBs are debt obligations issued by cities, and urban sector related governmental entities to raise money in order to finance urban infrastructure

Through MBs, investors lend money to an issuer who promises to pay the investors a specified amount of interest (usually paid semiannually) and return the principal on a specific maturity date

TYPES OF MUNICIPAL BONDS

General obligation bonds. Principal and interest are secured by the full faith and credit of the issuer and usually supported by either the issuer's unlimited or limited taxing power. General obligation bonds are also voter-approved.

Revenue bonds. Principal and interest are secured by revenues derived from tolls, charges or rents paid by users of the facility built with the proceeds of the bond issue. Public projects financed by revenue bonds include toll roads, bridges, airports, water and sewage treatment

facilities, hospitals and housing for the poor.

MUNICIPAL FINANCING IN INDIA

Traditionally financed through mix of– budgetary allocations from Municipality’s own revenues– grants from state government– borrowing from insurance companies and specialised national

level institutions like HUDCO and state level financial institutions – limited borrowings from banks/FIs

Capital Market access yet at a nascent stage – only 4 years since first municipal bond issue

Total Value of Municipal Bonds so far - Rs 7.5 bn Strong interest from several municipal bodies to issue similar bonds

– a dozen have already accessed capital markets– 40 Urban Local Bodies have sought rating

Bond Issuance provide alternate sources of Institutional finance not conventionally available to municipalities

MUNICIPAL BOND ISSUANCES THUS FAR

Municipality / Local Body Year Rating Amount (Rs crore)

Coupon (%)

10 yr G-Sec yield

Ahmedabad Jan 1998 AA(SO) 100.00 14.00 13.3

Bangalore Nov 1998 A(SO) 125.00 13.00 12.2

Ludhiana Sept 1999 LAA(SO) 17.80 14.00 11.6

Nashik May 1999 AA(SO) 100.00 14.75 11.7

Bangalore Water Supply Bd. Aug 2000 Not Avail. 10.00 12.90 11.4

Kanpur Dec 2000 LA+(SO) 50.00 13.50 10.9

Madurai Mar 2001 LA+(SO) 30.00 12.25 10.3

Ludhiana Jun 2001 LAA-(SO) 2.00 13.50 9.3

Tamil Nadu Urban Dev. Fund Aug 2001 LAA+(SO) 106.10 11.85 8.9

Nagpur Nov 2001 LAA-(SO) 31.10 13.00 7.8

Ahmedabad Mar 2002 AA(SO) 100.00 9.00 7.4

Hyderabad Mar 2002 AA+(SO) 82.50 8.50 7.4

KEY FEATURES OF AMC BOND ISSUANCE

First Municipality Bond Issuance in India Issue Size of Rs 1000 mn

• Rs 750 mn privately placed with 13 banks and institutional investors

• Balance Rs 250 mn by way of public issue in January 1998 Standalone rating of A+ enhanced to AA(SO) based on Escrow of

Octroi collections from 10 identified points (nakas) Credit enhancement (escrow) provided prioritisation of cash flows for

payments to bondholders No State / Local Government Guarantee / Support for debt servicing Funds utilised for pre-identified Water Supply and Sewerage Schemes Process took over a year to develop and deliver “first time in India”

KEY TERMS OF ISSUE

Issue Size : Rs 1000 mn Purpose : To part finance Water and Sewerage

projects Interest : 14% p.a. (G-Sec yield 13.35%) Tenor : 8 years Redemption : At end of 6, 7 and 8th years Security : - First mortgage and charge on corporations

property subject to minimum 1.25 times cover

- Structured Payment Mechanism by way of Escrow

Listing : National Stock Exchange Credit Rating: CRISIL AA(SO)

AHMEDABAD MUNICIPAL CORPORATION BOND – 2ND ISSUE

Arranger for AMC City 2002 Tax-free Bonds in March 2002

Issuer Ahmedabad Municipal Corporation

Instrument Tax Free Bonds

Rating AA(SO) by Crisil

Yield 9% payable semi-annual (10 yr G-Sec yield 7.45%)

Tenor 10 years with put/call at end of the 5th Year

Issue Size Rs 50 Crore, greenshoe option to retain additional Rs 50 Crore

Issue Open & Close

March 16, 2002 & March 31, 2002

Amount Mobilised Rs 108 Crore

Amount Retained Rs 100 Crore

KEY HIGHLIGHTS

Nashik – AA(SO)– Escrow of octroi– Inability to implement security structure led to rating downgrade -

subsequently restored Ludhiana – LAA-(SO)

– Escrow of non-tax revenues like water charges Hyderabad – AA+ (SO)

– Combination of escrow and cash collateral– Replicable model for corporations with substantial revenue

surpluses Bangalore - Guaranteed by State Government; Rated A+(SO)

– Non-utilisation of proceeds resulted in negative carry on bond interest

Madurai – LA+(SO) credit enhancement by GoTN’s guarantee– Escrow of Toll collections on Madurai Inner Ring Road

Nagpur – LAA-(SO)– Escrow of property tax and water charges

MUNICIPAL BOND ISSUES - KEY LEARNINGS SO FAR

Implementation of commercial accounting framework Institutional preparedness to identify, implement and

profitability operate projects and schemes Important to position municipality on stand alone basis

without state government cover Development of appropriate payment security mechanisms

to raise investor confidence and rating Stagger resource raising to align with projected spend

profile and in present context also take advantage of softening interest regime

WHAT IS CREDIT RATING?

Rating agency’s opinion on relative degree of safety regarding debt obligations being met on time

Its an opinion not a recommendation Relative degree of safety vis-a-vis other debt

instruments Timeliness in meeting debt obligation 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

CREDIT RATING - WHY?

Independent & unbiased evaluation of credit quality Increased accessibility to funds from the capital

markets for infrastructure projects

- Helps the investors in pricing the debt offer Increased marketability of debt issues by municipal

entities Improved visibility - facilitate flow of international

capital Indicative of transparency

CREDIT RATING - WHY?

Benchmarking with other municipal entities and corporate entities - highlights strengths and weaknesses

Use of market borrowings to bridge demand-supply gap in critical infrastructure can accelerate economic growth in the municipal area

Municipal corporations like Ahmedabad, Bangalore & Nasik have used market borrowings to fund capital expenditure

Helps in monitoring overall debt level & finances

RATING METHODOLOGY FOR MUNICIPAL BONDS

CRISIL’s 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

LEGAL AND 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

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

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

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

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

PROJECT DETAILS

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

envisaged

CREDIT ENHANCEMENT STRUCTURE

Escrow of specific tax revenues: Ensure non co-mingling of cash flows Level of collateralisation Reliability of source (e.g. octroi)

SG guarantee Credit quality of guarantor Legal validity Conditional/unconditional Irrevocability Trustee’s powers to invoke guarantee

CARE’S CRITERIA FOR EVALUATING MUNICIPAL BONDS

Considers the following parameters: Fiscal profile of the bond issuing municipal

body Project being financed and its related risk

factors Economic Factors Revenue streams for repayment of Bonds Level of local government autonomy Administrative Capability of the officials at

the local government level

ICRA’S CRITERIA FOR EVALUATING MUNICIPAL BONDS

ICRA looks at the overall profile of the issuer municipality in terms of – Service area and extension– Demographic profile within the municipal

limits– Social economic indicators in the district in

which the municipality is situated– Detailed financial assessment of the past

financial performance

CRITERIA USED BY THE INTERNATIONAL CREDIT RATING AGENCIES

STANDARD AND POOR’S CREDIT RATING METHODOLOGY

The analytical methodology focuses on :– Range of economic system and administrative

factors– Budgetary performance and flexibility– Entities own financial position– Evaluates Sovereign related factors and credit

profile of local governments

KEY HIGHLIGHTS AND LEARNINGS Few municipal entities with high stand alone credit quality Declining operating surpluses on account of rising revenue

expenditures due to 5th pay commission impact Pressing need for creating urban infrastructure assets to

improve quality of civic services Administrative reforms are the key to improving overall

profile and credit quality of local bodies

Credit rating has now become widely accepted as a self evaluation tool and a feedback for reform initiatives undertaken

FINANCIAL BENCHMARKING OF MUNICIPAL ENTITIES

Figure based on99-00 actualresults

Surat Nasik Vadodara Ahmdabad Bangalore Hyderabad Valsad Anklswr

RevenueReceipts(RR) (RsCrore)

377 169 205 566 300 195 7 5

5 yr CAGR of RR 15% 14% 15% 12% 16% 18% 12%OWN TAXES(%of RR)

79% 75% 72% 69% 41% 43% 17% 14%

% of Incomethrough SG ( % ofRR)

8% 6% 17% 22% 36% 39% 65% 74%

OCTROI ( % ofRR)

59% 64% 47% 48% COMPENSATION FOR OCTROI

PROPERTYTAX(% of RR)

20% 11% 24% 21% 40% 40% 17% 14%

RevenueExpenditue (RsCr)

263 113 173 442 296 167 5 4

5 yr CAGR of RevExp

19% 19% 18% 14% 19% 27% 19%

SALARY EXP (% OF RE)

59% 36% 57% 53% 50% 51% 71% 45%

COMPARISON OF REVENUE SOURCES

Category 1 Surat, Nasik Very High Own Income ( > 80% high collectionefficiency)

Category 2 Ahemdabad, Vadodara Fairly High own income ( 65-70%)Moderate dependence on SG

Category 3 Hyderabad, Bangalore Very high dependence on SG for RRCategory 4 Valsad, Ankleshwar High dependence coupled with small size

96-97 97-98 98-99 99-00Nasik 54% 46% 48% 43%Surat 47% 38% 38% 43%Bangalore 11% 17% 23% 33%Hyderabad 18% 25% 22% 21%Ahemdabad 20% 17% 18% 30%Vadodara 4% 10% 13% 17%Ankhleshwar 38% 30% 33% 33%Valsad 26% 25% 13% 15%Category 1 Surat, Nasik >40%Category 2 Hyd, Ahmd, Ban, Ank 20-40%Category 3 Vadaodara, Valsad <20%

CAPITAL EXPENDITURE / TOTAL EXPENDITURE

Ahmdabad Vadodara Surat Ankleshwar ValsadCost RecoveryWater 55% 60% 85% 20% 50%Sewarage 120% 150% 170% 20% 15%

COST RECOVERY ON KEY SERVICE

DSCR 96-97 97-98 98-99 99-00 ORS/Debt Curr Debt ( Mn)Nasik 47.5 57.3 33.0 3.7 52.5% 1062Surat 8.7 6.7 4.6 3.6 88.4% 1285.7Hyderabad 208.2 201.6 423.9 21.9 27.8% 0/1000*#Ahemdabad 2.9 1.7 1.8 1.5 37.5% 3308.8Bangalore 1.9 1.5 2.8 0.1 2.1% 2003.4Vadodara 1.8 2.0 0.9 0.7 32.4% 983Ankhleshwar 8.7 4.5 7.3 11.7 25.7% 14.62Valsad 8.1 11.6 6.5 10.2 51.8% 36.5Category 1 Surat, Nasik, Ank,Val DSCR > 3, OS / D>50%Category 2 Hyderabad, Ahemdabad DSCR 2-3, OS/D 30-50%Category 3 Bangalore, Vadodara DSCR < 2, OS/D < 30%* ORS/D BASED ON 100 CRORE DEBT PLANNED, PREVIOUS DEBT=0#DSCR CALC ON BASIS OF Rs 15 cr ANNUAL DEBT SERVICE, 99-00=1.85

DSCR : Operating surplus / debt service ( int, sink fund)

EMERGING TRENDS IN URBAN SECTOR Urban sector is at the cross roads Availability of resources in the financial sector is not a

constraint Channeling these resources to the urban sector is crucial Flow of resources to the urban sector will be facilitated by

enhanced perception of credit quality of these entities in the financial markets and well structured projects

Few municipal entities with high stand alone credit quality Sharp distinctions in credit quality between octroi and non

- octroi levying bodies.

EMERGING TRENDS IN URBAN SECTOR Improving the credit/fiscal profile of Urban

Local Bodies in the crux of Urban Sector Reforms– Financially sound entities would be in a

position to invest in civic infrastructure– They would also be in a position to attract

private sector capital - both through capital markets as well as PSP

LESSONS FROM MUNICIPAL BOND EXPERIENCE

Urban local bodies are open to new concepts and ideas Number of Local bodies have attempted to improve their

finances and quality of civic services through administrative measures

– Ahemdabad, Surat, Ludhiana, Vijaywada, Vizag………

While initiative for these administrative reforms may have come from pro - active CEO’s there is a broad based acceptance at both political and employee level of the need to change

LESSONS FROM MUNICIPAL BOND EXPERIENCE Ahemdabad, Surat have had a demonstrative effect on

other cities, this competitive spirit needs to be encouraged While actual number of municipal bond issuances have

been few, credit rating has now become widely accepted as a self evaluation tool and a feedback for reform initiatives taken

Credit rating, fiscal incentives now offered on municipal bonds, Proposed “Challenge Fund” need to be judiciously used to sustain the momentum of reforms in the urban sector

IMPLICATIONS FOR THE URBAN SECTOR REFORM AGENDA Administrative reforms at the local level need to be pushed

to improve financial profile under existing legal framework

– Accounting and MIS improvement

– Tax assessment and collection processes

– Enhancing own revenue base in existing tax structure

– Expenditure control, manpower rationalization need to be looked into

– Norms for expenditure also need to be evolved, particularly R&M

– Commercialization of operations

– Professionalism in management

IMPLICATIONS FOR THE URBAN SECTOR REFORM AGENDA

Training and technical assistance should focus on the following to maximize the impact of reforms– Project conceptualization and development,

financing and management– Financial Accounting and MIS, Computerization– Treasury management– Costing and pricing of services– Public Private Partnerships including familiarity

with Bid Evaluation, Bid process management

IMPLICATIONS FOR THE URBAN SECTOR REFORM AGENDA

Policy level issues

– Is municipal bond driven financing of urban projects more workable than private sector investments in projects at this juncture

– Should smaller private sector projects be encouraged first?

– Improving creditworthiness hinges on enhancing revenues through property tax reforms, levy of user charges, rationalizing costs, improving MIS and facilitating private investment, wherever feasible

POLICY ISSUES

While some municipal entities may be able to achieve an improvement in financial profile, structural changes involving higher levels of government may be necessary in other cases

The City Challenge Fund seeks to provide incentives to cities to embank on reforms that will lead to sustainable improvement in financial profile and quality of services delivered to the residents

In order to ensure sustainability of municipal finances and service delivery, cities would need to choose a comprehensive and far reaching reform agenda which needs to be developed to meet specific local requirements. Further, local ownership of the same is critical in order to facilitate its implementation

THANK YOU