The parameters that are considered in credit rating of municipal bodies may be broadly classified under the following heads:
Economic base
The basis of a community’s fiscal health is its economy which affects its major revenue sources such as Octroi, property taxes etc. Economic conditions dictate the quantity and quality of services delivered. The first step is, therefore, a study of the issuer’s location, infrastructure, natural assets, liabilities etc. The other factors would include the tax base, its composition and the employment base.
The ability to repay debt, without excessive reliance on government grants, ultimately depends on adequate income levels in the local area. Hence, from a rating angle, an area having an economically diverse tax and service base is a positive factor. However, these base strengths need to be tapped through an efficient tax structure. Also a strong service base needs to be reflected in commercially priced urban services. Generally, those communities with higher income levels and diverse economic bases have superior debt repayment capabilities.
Legal factors
The revenue raising powers of municipal bodies and the degree of actual control over some of these revenues, considering consumer resistance to tax and user charge hikes, need to be analysed. Borrowing and repayment powers are studied with reference to the authorization(s) required for raising debt and the overall limits on borrowing. Also, the effectiveness of collection enforcement mechanisms of municipal bodies need to be studied.
Administrative factors
Here, the organizational structure is analysed to evaluate the depth of management and extent of delegation of powers. Track record in project implementation is studied to evaluate project management capability as well the likelihood of completion of future projects without cost and time overruns. The ability to revise taxes and user charges and effectiveness in ensuring compliance is also reviewed. The management information systems are studied to evaluate the control and planning processes.
Timeliness of budget adoption is another factor considered since the budget is an expression of administrative capability. Timely adoption reflects cohesiveness in both the administrative and political processes. Late budgets are a hindrance to planning and an indication of political difficulty. The administration is expected to exhibit a willingness to make revenue and expenditure adjustments to ensure a realistic operating budget.
Debt factors
The analysis of debt focuses on the debt structure, the current debt burden, the future financing needs of the issue and the nature of any commitment of dedication of cash flows. The analysis includes a study of the current and past trends in the composition of debt, in terms of the cost and maturity. Track record of past debt servicing and debt service capability for future debt are analysed to assess both the capability and the willingness to service debt. The impact of any prior charges on cash flows on future debt servicing is evaluated. Also, any recourse available to lenders in case of default by the issuer, as per the governing municipal Act, will be examined. Any cap on total debt and its impact on financial flexibility will be analysed.
Financial factors
The financial condition of the issuer is evaluated through an analysis of financial statements. The quality and nature of assets and liabilities as well as composition, trends and stability of revenue and expenditure and their composition are studied. The ability of the issuer to maintain buoyancy of revenues through regular increases in taxes and user charges and better collection efficiency is studied. Further, the ability of the issuer to curtail wasteful expenditure and improve operational efficiency is analysed. The ability of the issuer to maintain a revenue surplus and service current and future debt is evaluated. The prioritization of past capital expenditure as well as their financial implications are studied to evaluate the financial planning process of the issuer. Also, flexibility of the issuer in raising resources to meet unforeseen contingencies is studied.
The budgetary and planning processes are studied while actual performance is measured against each year’s budget. Accounting and reporting methods peculiar to municipal bodies are noted.
Budgetary support from the state government in the form of grants form a large component of revenues in some municipal bodies. The stability of these revenues would depend on the finances of the respective state government. Hence, for assessing the creditworthiness of these municipal bodies, the finances of the state government needs to be analysed. Parameters to be analysed include the economic condition of the state, major sources of revenue and expenditure, stability and trends of major revenue streams, current and past trends of revenue surplus/deficit, tax base, stability and trends of transfers from the centre, current and past debt profile, debt servicing capability, disbursement schedules for grants and their timeliness etc.
Project viability
This involves an in-depth study of the project being funded including committed sources of finance, assumptions behind projected revenue and expenditure over the tenure of the instrument, extent of cost recovery through user charges, availability of general revenues for debt servicing and committed budgetary support, if any, for the above project. Credit enhancement measures, if any, are evaluated to assess impact on timely servicing of debt. Also, sensitivity analyses may be conducted for cost and time overruns, cost of borrowing and user charge increases. In the case of a revenue bond, only revenue streams from the project are used for debt servicing.
Considering the above factors, the important parameters to be studied in the credit rating of municipal bonds could include the following:
A. Economic factors
- Nature of local economy;
- Local employment and income characteristics;
- Development indicators and current availability of urban services.
B. Legal set-up
- Borrowing powers and limits;
- Pending litigation’s or disputes;
- Powers of taxation;
- Powers to levy user charges;
- Actual control over revenue sources considering the political implications of tax and user charge hikes;
- Collection enforcement mechanisms under the Act and restrictions on operations;
C. Administrative factors
- Organizational structure;
- Division of responsibilities between the Administrative and Political wings;
- Quality and continuity of management, extent of delegation;
- Depth of management ; extent of delegation;
- Tax billing, collection and enforcement mechanism;
- Track record in project implementation;
- Degree of autonomy enjoyed by the local body;
- Management Information System;
- Industrial relations.
D. Accounting and Auditing Practices
- Systems of accounting;
- Nature and quality of audit.
E. Debt Factors
- Composition of current debt burden;
- Interest and debt service coverage ratios;
- Past debt service performance;
- Evaluation of credit enhancement mechanisms, if any;
- Commitments/encumbrances on cash flows;
- Degree of reliance on short term borrowings;
- Maturity matching profile;
- Recourse available to lenders, in case of default, as per the Act.
F. Financial Indicators
- Fiscal data on the issuer;
- Budgetary and planning processes;
- Tax base and past trends;
- Composition and timing of revenue and expenditure, past trends;
- Trends in tax rates and user charges;
- Extent of cost recovery on various urban services;
- Financial flexibility to meet unforeseen contingencies;
- Revenue surplus/deficit;
- Extent of State budgetary support;
- Operating and collection efficiency;
- Sources and allocation of capital expenditure, trends;
- Extent of borrowings, if any, from non-governmental sources and the degree of compliance with the credit discipline imposed by such lenders.
G. Finances of state government
- Trends of revenue surplus/deficit, revenue deficit/Gross Fiscal Deficit;
- Interest payment/Revenue expenditure; Debt servicing/Gross transfers;
- Non-development exp./Aggregate disbursement; Tax revenues/Revenue exp.;
- Gross transfers/Aggregate disbursements;
- Trends in overall deficits and Gross Fiscal Deficits.
H. Project Viability
- Constitution of the project as a departmental project or an SPV;
- Sources and uses of funds for project being financed;
- Analysis of projected revenues and expenditure for the tenure of the instrument as well as the underlying assumptions ;
- Revenue flow pattern from the project and extent of cost recovery;
- Committed budgetary support and other credit enhancement measures;
- Sensitivity analyses to user charge hikes, cost of borrowing etc.;
- Evaluation of credit enhancement measures, if any.