India - Tamil Nadu Water Pool Rating - Fitch (2003).pdf - The Global ...

Public FinanceIndia – Public FinanceCredit AnalysisNational RatingsSecurityClassUnsecured StructuredBonds (Rs 304.1 mn)CurrentRatingAA(ind)(SO)PreviousRatingNILLong-term Outlook .......................................... StableRating Watch...................................................... NoneAnalystsSudhir N Variyar91-22-5637 0920sudhir.variyar@fitchratings.comPraful Kumar Chhajer91-44-2431 3339praful.chhajer@fitchratings.comN Raju91-44-2431 3338n.raju@fitchratings.comCompany ContactR Venkataraman91-44-2815 3103venkataraman@tnudf.comProfileWater & Sanitation Pooled Fund (WSPF) is aspecial purpose vehicle incorporated under theIndian Trust Act 1882 with an initial contributionfrom the Government of Tamil Nadu (GoTN) toenable urban local bodies (ULBs) pool finance theirwater and sanitation projects at market rates. TamilNadu Urban Infrastructure Financial Services Ltd(TNUIFSL) is the manager of the fund. WSPF hasdisbursed the amount raised to 13 ULBs, includingeight Adjacent Urban Areas (AUAs) who aresmaller ULBs forming part of the ChennaiMetropolitan Area.Key Credit Strengths• Escrow of revenues of ULBs• Revenue intercept of State FinanceCommission devolution (SFCD) to the ULBsfrom GoTN• Cash collateral in the form of Bond ServiceFund (BSF) of Rs 69 mn• USAID guarantee for 50% of the principalKey Credit Concerns• GoTN credit risk• Sharp deterioration in municipal financeswhich could affect operation of the revenueinterceptWater And Sanitation PooledFund (WSPF)• TransactionWSPF has raised Rs304.1mn of 9.2% unsecured structured bonds.The bonds have tenure of 15 years with a Put/ Call option at theend of 10 th year. Principal repayment is in 15 equal annualinstalments, and interest is payable annually on diminishingbalance. The proceeds from the issue have been lent back-to-backto 13 ULBs in Tamil Nadu at 9.2% to enable them either torefinance their existing loans obtained from Tamil Nadu UrbanDevelopment Fund (TNUDF) or to provide finance, as the casemay be, for water supply and sanitation projects.The bonds would be serviced through a repayment mechanisminvolving an escrow of property tax and other revenues of theULBs. Additional credit enhancement is available from a provisionto intercept SFCD from GoTN to these ULBs in the event ofinsufficient funds in the escrow, a cash collateral of Rs69mn asBond Service Fund (BSF), and a guarantee from United States’Agency for International Development (USAID) to replenish 50%of principal component of amount drawn from the BSF upto amaximum of 50% of outstanding loan principal. Indian Bank is theTrustee to BSF. The fact that SFCD to ULBs is monthly in natureadds to rating comfort. Please refer Annexure II for transactionstructure.• Rating RationaleThe key credit strength of WSPF’s bond issuance is the revenueintercept provisions provided in the structure. All the revenues ofparticipating ULBs (including property tax, user charges and SFCdevolutions from GoTN) would be routed through no-lien escrowaccount held with a bank. To address the liquidity risks arising outof mismatch in revenues to the ULBs and the annual repaymentprofile, the repayment mechanism envisages monthly contributionsby the ULBs to a separate Fixed Deposit (FD) account for 10months, at the end of which adequate funds would be set aside forthe next annual payment and the banker would transfer the balancein FD account to WSPF. In case of any shortfall in these monthlycontributions, there is a provision to tap SFCD to the ULBs. Therepayment mechanism is discussed later in the report.The rating draws comfort from the BSF, which has been set up byGoTN with an initial contribution of Rs69mn. The BSF willremain invested in liquid securities and covers 1.43 times firstyear’s bond service. Any shortfall in the amount due to bondinvestors would be met by drawals from the BSF. In case ofdrawals from BSF, GoTN would replenish the BSF to the extent of100% interest and 50% of the principal component of the drawalby withholding the SFCD to the ULBs. The balance 50% of theprincipal component is covered by a guarantee from the USAID.June 2003www.fitchratings.com

Public FinanceIn case of Put/Call option being exercised at the endof 10 th year, WSPF would pay the outstandingprincipal of Rs101.4mn, from the BSF and frominterest and capital gains, if any, accrued over tenyears from BSF investments and cumulative FDs, tothe bondholders. Fitch’s rating does not address thepayment under the Put/Call Option, and is meant toaddress the timely payment of interest andrepayment of principal by the scheduled maturity of15 years.Fitch has done a cash flow stress test. The USAIDguarantee and the initial contribution of the BSFalone are adequate to support a 49% default of theloan pool for a four-year period. For a local bodyloan pool, Fitch considers this to be adequateprotection for the proposed rating.In assigning the rating, Fitch has taken intoconsideration the provisions under Article 243Y ofthe Indian Constitution, which provides for SFCs torecommend the scheme of distribution of taxescollected by the State between the local bodies andthe State (Annexure III). This distribution is similarto that of certain central taxes between the Centraland the State governments. Fitch has thereforeassumed that the devolution to the ULBs will takeprecedence to any other general obligations ofGoTN. The rating is however influenced by theGoTN’s finances and any deterioration in the samewill affect the rating.• WSPFGoTN has formed WSPF in order to identify viableurban infrastructure projects of the ULBs and fundthem from concept to commissioning on acommercial basis. WSPF thus enables the ULBs topool their requirements and tap low-cost marketfunding for their projects. WSPF is governed by aBoard of Trustees, which is nominated by GoTN andcomprises senior officials of GoTN, and is managedby TNUIFSL.WSPF has disbursed the proceeds of the issue to apool of ULBs either to refinance their high-costloans obtained from TNUDF or to finance, as thecase may be, their water supply and sanitationprojects. The loans were extended by WSPF toULBs of Ambattur, Madhavaram, Tambaram andRajapalayam for water supply projects, to MaduraiMunicipal Corporation for its underground drainageproject, and to eight AUAs for the water supplyaugmentation scheme of Chennai MetropolitanWater Supply and Sewerage Board (CMWSSB). Allthese projects have either been completed or are inadvanced stages of completion.Table 1: Break up of Loans to ULBsSl Particulars Rs mn %Water Supply Schemes:1 Ambattur Municipality 6.7 2.22 Tambaram Municipality 10.9 3.63 Madhavaram Municipality 10.6 3.54 Rajapalayam Municipality 5.1 1.7Adjacent Urban Areas - AUAs5 Alandur Municipality 40.3 13.36 Pammal Town Panchayat 35.7 11.77 Ankapathur Town Panchayat 17.8 5.98 Ullagaram Town Panchayat 28.1 9.29 Porur Town Panchayat 54.7 18.010 Maduravoyal Town Panchayat 13.8 4.511 Valsaravakkam Town Panchayat 17.9 5.912 Meenambakkam Town Panchayat 1.6 0.5Sub Total – AUAs 209.9 69.0Total - Water Projects 243.2 80.0Under Ground Drainage:13 Madurai Corporation 60.9 20.0Grand Total 304.1 100.0Source: TNUIFSL• Credit Quality of the ULBsWSPF has extended loans to eight AUAs, whichcomprise 69% of the total amount lent, and loans tofive other ULBs, which comprise the balance 31% ofthe pool. A brief financial profile the ULBs isprovided in Annexure I.Some of the key characteristics of the finances of theULBs are:• Until recently they followed a Cash-basedaccounting policy (i.e. Accounts Receivable,Accounts Payable, etc., are not captured). Oflate, in Tamil Nadu municipalities have nowswitched to accrual-based accounting and theTown Panchayats propose to do so shortly.• The accounts could be divided into the RevenueAccount, consisting of Revenue Receipts andRevenue Expenditure, and Capital Account,consisting of Capital Receipt and CapitalExpenditure.• The ULBs in the pool, excluding the four AUAswhose accounts were not available, are allrevenue surplus. The surpluses projected for2001-02 by TNUIFSL ranges from 6.2% to63.3% of their Revenue Receipts.• For 2001-02, TNUIFSL has projected the debtservice as a proportion of Revenue Receipts torange from 3.7% to 26.4%.Water And Sanitation Pooled Fund (WSPF)2

Public Finance• Revenue Receipts comprises own taxes,principally property taxes, that are revisedperiodically to align to property prices, and ashare of State government taxes, which alsoshow robust increases. Revenue Receipts forsome of the ULBs over five years have grown ata compounded rate of 6% to 30%.• The Capital budget could vary significantlyfrom year to year depending on projects beingimplemented. However, the Capital Receipts, ofwhich grants from the State government form asignificant portion, could also be used to supportdebt repayments.While the ULBs have low debt servicing burden,they are Revenue surplus and they havedemonstrated ability to grow revenues at a steadyrate. The credit quality is constrained by the cashbasedaccounting systems (although recentlymunicipalities in Tamil Nadu have moved to accrualbased accounting) which do not give an accuratepicture of liabilities, the lack of availability ofregular financial information and an own revenuebase which is principally dependent on one sourcei.e. property taxes. On a standalone basis the creditquality of the ULBs would be in the low investmentgrade range.However, Fitch believes that the ULBs will continueto have significant State government support. As theULBs do not enjoy fiscal autonomy, their financialstrength is significantly dependent on the fundingfrom the State. The State Legislature decides on thetaxes that can be levied by the ULBs. The twoprincipal streams of revenue to a ULB are the owntaxes and the devolution of their share of State taxesand grants from State government. Typically, owntaxes contribute 50% to 80% of the revenue receiptsof the ULBs and it varies from year to year for eachULB. The rest of the Revenue Receipts are by wayof devolution of a share of State government taxes.Further, the ULBs are dependent on Capital Grants/contributions from the State/Central government tomeet capital expenditure necessary to provide theservices that have to be rendered by them.• Credit enhancementsThe following are the various levels of creditenhancements:1. Escrow of Revenues of ULBs: Each ULB willestablish a no lien escrow on its current accountthrough which its property tax and other taxcollections, and other revenues including SFCDare routed. Under a tripartite agreementexecuted between WSPF, ULB and its Bank,beginning 12 months before the due date, 1/10 thof annual debt service or amount as stipulatedby TNUIFSL would be transferred every monthto a separate Fixed Deposit (FD) account. Thetransfer to FD account would enjoy precedenceover any other commitment of the ULBs. TheFDs would be cumulative in nature, and at theend of 10 th month, the balances including theinterest would be transferred to WSPF’s accountmaintained to service the bondholders.2. SFCD Intercept – Any shortfall in themonthly payments would be made up fromfuture accrued SFCD to the respective ULBs.In the event that there is insufficient fund ornon-transfer to WSPF account 60 days priorto due date, TNUIFSL will call upon theGoTN to deduct the shortfall (First ShortfallAmount or FSA) from SFCD to defaultingULBs and pay to WSPF not later than 40 daysbefore the due date.3. Bond Service Fund (BSF): The Rs69mn BSFwill stay invested in liquid AAA(ind)/F1+(ind)rated or equivalent securities. In case, FSA isnot sufficient or there is a timing mismatch intransfer of funds to ULBs by GoTN, TNUIFSLwould ask the BSF Trustee to transfer theshortfall (Second Shortfall Amount or SSA) toWSPF account within 30 days before due date.4. USAID Guarantee and Restoration of BSF:For restoration of BSF, USAID has guaranteedto replenish 50% of principal component ofdrawal from the BSF (i.e. SSA). The claim forpayment by USAID has to be made not earlierthan three months after demand for full paymenthas been made by WSPF against defaultingULB, and not later than six months. The USAIDguarantee covers up to a maximum of 50% ofthe outstanding principal, i.e., Rs152.1mn, andthe guarantee cover would diminish as theprincipal is redeemed every year. GoTN wouldpay 100% of the interest component and 50% ofthe principal component of the amount drawnfrom the BSF and adjust the same againstSFCDs to defaulting ULBs within a period oftwo months after the due date.An Initial fee of 0.75% and an annual Utilisationfee of 0.5% of outstanding principal is payableto USAID. However, USAID has agreed to aone-time settlement of Utilisation fee. GoTNwould bear the guarantee fees payable toUSAID.• Stress TestThe cash flows of WSPF were subjected to a stresstest to test the loan pool’s vulnerability to a severeeconomic downturn. Fitch assumes that theWater And Sanitation Pooled Fund (WSPF)3

Public Financerepayment obligations of the local bodies areeventually likely to resume and be paid in full afterthe stress period, given their powers to raiseadditional resources through levy of taxes and usercharges, and also the inherently stable nature oftheir revenue sources due to monopoly of theirservices.Fitch has considered a period of four years as thesevere economic stress period. The initialcontribution to the BSF and top-up of BSF to theextent of 50% of principal (by USAID) alone aresufficient to meet the bond obligations during thisfour-year period even if 49% of the total loans givenby WSPF were to default during this period. Fitchconsiders this default tolerance to be adequate for thesuggested rating.• Payment MechanismTable 2 details the payment mechanism envisaged toensure timely payment to the bondholders.A tripartite agreement has been executed between theWSPF, the ULBs and their bankers for escrow of theULBs’ revenue account and monthly transfer of 1/10 thof annual debt service to a separate FD account, onwhich WSPF would have a lien. Sixty days prior tobond service date i.e. at the end of the 10 th month, theFDs would be transferred to WSPF’s account toenable servicing of bondholders. The paymentmechanism provides for time required by GoTN tomake good any shortfall if the escrow account is notadequately funded. The interest accrued from time totime from the investments of the BSF will betransferred to the WSPF’s bank account.Table 2: Repayment MechanismTDue Date of payment of interest and principal to bond holders or bond service amount (BS)T – 12 month,T- 11 months,T-10 month, and so on up toT-3 monthBank would pay 1/10 th of the BS or amount as decided by TNUIFSL from the escrow account ofthe ULB into a Fixed deposit (FD) account maturing on Day T- 60 days. The FDs, with cumulativeinterest option, would be maintained by the ULBs with a lien in favour of WSPF and shall not beencashed/cancelled/ modified/altered without written permission of TNUIFSL.Any shortfall in monthly payments by ULB(s) would be made up from the future SFCD accruing torespective ULB(s).T – 60 daysT – 40 daysT – 30 daysSource: TNUIFSL, FitchBalances in the FD accounts, alongwith interest would be transferred to WSPF account created toservice the bondholders.In case of any shortfall in funds or non-transfer of funds to WSPF, GoTN would be informed todeduct the shortfall (FSA) from the SFCDs (which are payable before 40 days from the bondmaturity date) of the appropriate ULBs and pay the same into the WSPF account.In case FSA is inadequate or there is a timing mismatch, the shortfall (SSA) would be made goodby drawing upon the BSF within 30 days before the due date.USAID (for 50% principal component of SSA) and GoTN (50% principal + 100% interest) will beinstructed to top up the BSF by day (T+2) months• Tamil Nadu Urban InfrastructureFinancial Services Ltd (TNUIFSL)TNUIFSL is a financial services Company managingthe funds of Tamil Nadu Urban Development Fund(TNUDF), which provides long-term finance forurban infrastructure. TNUIFSL also manages theGrant Fund, whose purpose is to enhance financial,managerial and project development capacities of theULBs. TNUIFSL manages TNUDF on the basis ofLending Policies and Procedures approved by theTrustee, and the Grant Fund on the bass ofguidelines issued by GoTN.TNUDF was established on November 29, 1996 as atrust under the Indian Trusts Act, 1882. Since 1988,GoTN is implementing the Tamil Nadu UrbanDevelopment Project (TNUDP) with assistance fromInternational Development Agency of World Bank,one of the components of which was the MunicipalUrban Development Fund (MUDF) for urbanfinancing. In 1996, the MUDF was converted intoTNUDF. TNUDF, which also has participation fromthree financial institutions viz. ICICI, HDFC andIL&FS, is the first public-private partnershipproviding long-term debt for civic infrastructure on anon-guarantee mode.Table 3: Financial Summary of TNUIFSLRs mn FY 02 FY 01Income 15.4 36.0PBIT 5.4 25.2PAT 3.3 14.8Networth 34.2 32.9Op Profit (%) 35.4 70.1PAT (%) 21.5 41.2Water And Sanitation Pooled Fund (WSPF)4

Public FinanceAnnexure III: Devolution to Local BodiesThe devolution of state government taxes arises from the provisions of Article 243Y of the Indian Constitution.The allocation is based on the recommendations of the State Finance Commissions (SFCs), normally appointedevery five years, which submits its recommendation to the Governor of the State.The devolution/transfers from the State Government to local bodies consists of two parts –a. Taxes collected by the State on behalf of the local bodies e.g. entertainment tax, surcharge on stamp duty,etc.b. Share of local bodies in State government’s taxes (excluding entertainment tax)The second portion makes up the substantial part of the devolution to the local bodies. The allocation ofresources is done based on the premise that these transfers are on revenue account only, are to be utilized onlyfor civic services by local bodies, and based on the financial position of the local bodies. The transfer involvestwo vertical levels and one horizontal level of distribution. The first vertical level is distribution between theUrban and Rural local bodies. This is based on population of these areas. The second vertical level of transfer isfrom the rural pool to District Panchayats, Panchayat Union and Village Panchayats, and from Urban pool toCorporations, Municipalities and Town Panchayats. This is based on the number of institutions involved, natureand level of civic service and staff deployed for the rural bodies. For transfers from urban pool, the funds aredistributed based on the population. The third level of transfer envisages horizontal distribution to individuallocal bodies both in rural and urban areas. The distribution among the Panchayat unions/Village Panchayats isbased on various parameters like population, total SC/ST population, financial viability and core civicinfrastructure deficiency. For distribution to the Corporations, Municipalities and Town Panchayats, the factorsconsidered are population, total SC/ST population, per capita receipt under own resources, and per capitaexpenditure on core civic services.The current SFC in TN has recommended that in FY 03 the rural and urban local bodies will receive 8 percentof the States Own Tax Revenues after excluding the Entertainment Tax receipts and amounting to Rs 15 bn. Thevertical sharing of resources between rural and urban local bodies will be in the ratio of 58:42. Of the totaldevolutions to the urban local bodies, the resources will be shared between the Corporations, Municipalities andTown Panchayats in the ratio 31:34:35. The devolution to rural local bodies will be shared among the VillagePanchayats, Panchayat Unions and the District Panchayats in the ratio of 47:45:8. The devolutions to localbodies would be made on a monthly basis in FY 03.9Water And Sanitation Pooled Fund (WSPF)

Public FinanceAnnexure IV: Summary of GoTN FinancesRs mn 1999-00 2000-01 2001-02 2002-03Accts Accts RE BEGross Fiscal Deficit -53,823 -50,760 -57,359 -88,950Fiscal Performance Ratios (%)GFD/GSDP -4.20 -3.70 -3.90 -5.70Revenue Deficit/GSDP -34.50 -25.00 -23.50 -39.90Revenue Growth (YoY) 14.50 12.20 3.60 8.70Expenditure Growth (YoY) 14.00 4.90 3.00 19.80GSDP Growth rate (YoY) - real 5.80 4.40 3.10 4.40Debt Ratios (%)Total Debt/GSDP 18.70 20.90 23.10 26.20Interest Payable/Revenue Receipt 16.60 17.10 18.80 19.20Revenue Ratios (%)States own Tax revenue/Total tax Revenue 80.40 81.50 82.00 81.70States own revenue/ Total Expenditure 54.30 57.30 56.00 51.00Total Tax revenue/ Total Revenue 83.20 82.30 83.40 84.60Expenditure Ratios (%)Pensions/Revenue Receipt 16.50 16.00 15.90 15.40Revenue Expenditure/Total Expenditure 91.60 89.00 86.30 87.10Source: State Finances: A Study of Budgets 2003-04, RBI; Ministry of Statistics & Program Implementation (Govt of India) websiteAnnexure V: Snapshot of GoTN FinancesRs mn FY 96 FY 97 FY 98 FY 99 FY 00 FY 01 FY 02 FY 03 RE FY 04 BEGross Fiscal Deficit (GFD) (12,550) (24,450) (21,220) (47,770) (53,820) (50,760) (47,390) (81,050) (69,440)Revenue Deficit (RD) (3,110) (11,040) (13,640) (34,360) (44,000) (34,360) (27,390) (59,170) (39,330)GSDP 784,375 895,604 1,035,122 1,191,272 1,275,355 1,371,892 1,462,654 1,576,848 1,706,143GFD/GSDP (%) -1.6 -2.7 -2.1 -4.0 -4.2 -3.7 -3.2 -5.1 -4.1Interest/Revenue Recpt(%) 12.2 12.3 13.0 14.9 16.6 17.1 18.7 20.3 20.1RD/GFD (%) 24.8 45.2 64.3 71.9 81.8 67.7 57.8 73.0 56.6RD/Revenue Recpt (%) 2.9 9.2 10.0 24.1 27.0 18.8 14.6 28.6 17.4Source: GoTN Budget 2003-04 Speech (www.tn.gov.in)Copyright © 2003 by Fitch, Inc. and Fitch Ratings, Ltd. and its subsidiaries. One State Street Plaza, NY, NY 10004.Telephone: 1-800-753-4824, (212) 908-0500. Fax: (212) 480-4435. Reproduction or retransmission in whole or in part is prohibited except by permission. All rights reserved. All of theinformation contained herein is based on information obtained from issuers, other obligors, underwriters, and other sources Fitch believes to be reliable. Fitch does not audit or verify thetruth or accuracy of any such information. As a result, the information in this report is provided “as is” without any representation or warranty of any kind. A Fitch rating is an opinion asto the creditworthiness of a security. The rating does not address the risk of loss due to risks other than credit risk, unless such risk is specifically mentioned. Fitch is not engaged in theoffer or sale of any security. A report providing a Fitch rating is neither a prospectus nor a substitute for the information assembled, verified, and presented to investors by the issuer and itsagents in connection with the sale of the securities. Ratings may be changed, suspended, or withdrawn at any time for any reason at the sole discretion of Fitch. Fitch does not provideinvestment advice of any sort. Ratings are not a recommendation to buy, sell, or hold any security. Ratings do not comment on the adequacy of market price, the suitability of any securityfor a particular investor, or the tax-exempt nature or taxability of payments made in respect to any security. Fitch receives fees from issuers, insurers, guarantors, other obligors, andunderwriters for rating securities. Such fees generally vary from US$1,000 to US$750,000 (or the applicable currency equivalent) per issue. In certain cases, Fitch will rate all or a numberof issues issued by a particular issuer, or insured or guaranteed by a particular insurer or guarantor, for a single annual fee. Such fees are expected to vary from US$10,000 toUS$1,500,000 (or the applicable currency equivalent). The assignment, publication, or dissemination of a rating by Fitch shall not constitute a consent by Fitch to use its name as an expertin connection with any registration statement filed under the United States securities laws, the Financial Services Act of 1986 of Great Britain, or the securities laws of any particularjurisdiction. Due to the relative efficiency of electronic publishing and distribution, Fitch research may be available to electronic subscribers up to three days earlier than to printsubscribers.Water And Sanitation Pooled Fund (WSPF)10