Fitch Ratings India has today assigned an expected rating of ‘AA(ind)(SO)´ to the INR450 million tax-free, long-term structured bonds issuance of the Water and Sanitation Pooled Fund (WSPF).
At the same time, the agency has affirmed the ‘AA(ind)(SO)´ rating on the existing INR304.1m structured bonds issued by WSPF in November 2002.
WSPF is the state-level pooled finance entity designated by the Government of Tamil Nadu (GoTN) to raise tax-free bonds under the guidelines of the Pooled Finance Development Fund (PFDF) scheme. PFDF was recently launched by the Ministry of Urban Development, Government of India (GOI) to encourage small and medium urban local bodies (ULBs) to raise funds from the market through a pooled finance framework for funding basic urban infrastructure projects.
This is first issuance under the new PFDF scheme and the bond proceeds will be disbursed to seven ULBs in the state of Tamil Nadu to finance their water supply and sewer projects.
The issue has been structured with multiple layers of credit enhancement that lend strength to the rating. By lending to a diversified portfolio of ULBs, the default risk for bond holders is lowered.
The rating benefits from an INR98m (or 21.8% of the issue) credit rating enhancement fund (CREF) that will be funded upfront by the GOI to an extent of 50% of the CREF or 10% of the issue size, whichever is lower, with the balance being contributed by the GoTN.
In case of withdrawals from the CREF, GoTN would replenish it to the extent of 100% of both interest and the principal component of the withdrawal by withholding the State Finance Commission Devolutions (SFCD) to the ULBs.
Statutorily constituted, State Finance Commissions (SFCs) review finances of urban and rural local bodies in a state and recommend provisions by which they can receive a share of the revenues of state governments. Additionally, each ULB will set up, upfront, a Debt Service Reserve Fund (DSRF) equaling one year’s principal and interest.
WSPF proposes to issue 20-year bonds with a five year principal moratorium followed by 15 equal annual repayments, interest being payable annually on the diminishing balance.
The bonds would be serviced through a repayment mechanism involving an escrow of project (for which the loan is being extended) revenues of the ULBs.
Under a tripartite agreement executed between WSPF, each ULB and its bank, beginning 12 months before the annual debt service date, 1/3 of annual debt service would be transferred at the end of every three months to a separate Fixed Deposit (FD) account.
The transfer to the FD account would enjoy precedence over any other commitment of the ULBs. The FDs would be cumulative in nature, and at the end of the ninth month, the balances including the interest would be transferred to WSPF’s account maintained to service the bondholders.
The loan covenants would also stipulate that in the event project revenues are insufficient for meeting the ULBs’ debt service obligations to WSPF, shortfall in debt service up to 20%, can be appropriated from general revenues for this purpose.
Any shortfall in the payments into the designated bond service account would be made up from future accrued SFCD to the respective ULBs.
Fitch has done a cash flow stress test under different scenarios: The initial contribution to the CREF alone is adequate to support a 20% default of the loan pool for two separate five-year periods - the first five years and the last five years of principal amortisation. For a local body loan pool, Fitch considers this to be adequate protection for the proposed rating.
In factoring in the intercept provisions in the structure, Fitch has taken into consideration the provisions under Article 243Y of the Indian Constitution, which provides for SFCs to recommend the scheme of distribution of taxes, collected by the State between the local bodies and the State.
This distribution is similar to the distribution of certain federal taxes between the Central Government and the State Governments.
Fitch has therefore assumed that the devolution from the state government to the ULBs will take precedence over any other general obligations of the State Government.
The rating is however influenced by the State Government’s finances and any deterioration in the same will affect the rating.
The entire structure will be administered and monitored by a trustee (rated at least ‘AA(ind)´) to be appointed by WSPF. The final rating will be assigned on completion of documentation, i.e. the ULB council resolutions, ULB loan agreements, tripartite agreements for escrow accounts, government orders for setting up the CREF, trust deed, etc.
WSPF is a special purpose vehicle incorporated under the Indian Trust Act 1882 with initial contribution from the Government of Tamil Nadu (GoTN).
Tamil Nadu Urban Infrastructure Financial Services Ltd (TNUIFSL), the fund manager of the Tamil Nadu Urban Development Fund - an infrastructure development financial intermediary set up by GoTN on the public private partnership model with ICICI Bank Ltd., Housing Development Finance Corporation, and Infrastructure Leasing & Financial Services Limited, to finance urban infrastructure requirements throughout the state- is also the manager to the WSPF.