Detailed Rationale

CRISIL Ratings has assigned its 'Provisional CRISIL AA+/Stable' rating to the Rs 200 crore proposed green municipal bond of Surat Municipal Corporation (SMC), and has reaffirmed its ‘CRISIL AA+/Stable’ rating on the existing Rs 200 crore bond programme of the corporation.

 

The ratings reflect the strong creditworthiness and low performance risk of SMC, along with moderate debt service coverage ratio (DSCR) leading to low impact of future flow on other obligations of the corporation. The linkage of inflow to the performance of SMC is low as the inflow is dependent on own-revenue. Expected high DSCR, coupled with stable (yet growing) inflow and low debt, will keep the financial risk profile comfortable. The bonds have a well-defined structure for escrow account, payment structure and points of recourse in case of shortfall in cash flow. The ratings also reflect the strength of the trustee-administered escrow account, payment mechanism and adequate liquidity in the form of a debt service reserve account (DSRA) equivalent to 12 months of interest obligation.

 

SMC is expected to issue the green municipal bond in coming months, subject to execution of documents and fulfilment of other requirements mentioned in this rating rationale.

 

The ratings also consider the robust operating performance and strong financial risk profile of the corporation, driven by healthy operating surplus, small debt, superior liquidity and adequate debt protection metrics. Furthermore, SMC has sound economic base, adequate service levels, optimal collection efficiency of taxes and charges, and good reform orientation.

 

These strengths are partially offset by heavy reliance on state government grants and large capital expenditure (capex) requirement.

Analytical Approach

To arrive at its ratings, CRISIL Ratings has applied its criteria on future flow securitisation.

Key Rating Drivers & Detailed Description

Strengths:

• Strength of the escrow mechanism

The escrow and bond payment mechanism provide adequate strength to the bond issuance. For the green municipal bond, own-revenue escrowed at collection, trustee-managed escrow mechanism and payment structure with recourse to the originator ensure sufficient safety for timely debt servicing. For the existing bond, which is due for redemption in March 2024, tax receipts escrowed at collection, trustee-managed escrow mechanism and payment structure with recourse to the originator ensure adequate safety for timely debt repayment. Creation of the DSRA in case of both the bonds before pay-in and maintenance of the same throughout the tenure of the bonds enhances the strength of the structure. The DSCR is expected to be high throughout the tenure of the bonds.

 

• Strong financial performance, reflected in healthy operating surplus

Revenue includes income from collection of property tax, user charges for water and sewerage service, income from other taxes such as professional tax, octroi compensation, other revenue grants and other non-tax income. Revenue surplus is healthy, backed by strong property tax collection and steady grants from the state government in lieu of octroi and non-tax income, comprising town development income. Fiscal 2023 revenue surplus of Rs 396 crore was in line with fiscal 2022 surplus of Rs 408 crore, amid increased establishment expenses. The corporation has revised property tax, other tax and user charges, which increased revenue surplus (before sinking fund contribution) to Rs 485 crore as of November 2023 (Rs 436 crore for the full fiscal 2023).

 

• Comfortable financial risk profile

Healthy operating surplus has helped the corporation to fund increasing capex through internal cash accrual, leading to low reliance on debt. As on March 31, 2023, outstanding debt was Rs 200 crore (on account of municipal bonds raised in March 2019). Robust cash flow generates ample liquidity. Unencumbered cash and equivalent stood over Rs 645 crore as on March 31, 2023, including bank balance and fixed deposits. SMC will maintain its cash balance over the medium term.

 

The corporation has large capex planned under the Atal Mission for Rejuvenation and Urban Transformation (AMRUT) and Smart City projects, which is being funded through a mix of government grants and own-revenue surplus. Despite the debt, debt protection metrics will remain strong over the medium term. Regular receipt of octroi compensation and capital grants from the state government will be key monitorables.

 

• Adequate service levels and healthy collection efficiency of taxes and charges

SMC has strong civic infrastructure and robust delivery systems, which are reflected in good water supply coverage, adequate road and sewerage networks, and improving drainage and solid waste management practices.

 

The collection efficiency of property tax has increased steadily after the Covid-19 pandemic to around 94% in fiscal 2023 and around 91% in fiscal 2022. The cost of recovery for essential services is among the highest compared with other corporations in the state. Implementation of AMRUT and Smart City projects should further drive improvement in service levels and collection efficiency of taxes and charges.

 

• Sound economic base

The robust industrial base of Surat, its favourable location, strategic importance in the state and high per-capita income have led to sound economic base. Industries in Gujarat have flourished because of favourable state government policies, affordable cost of living, surplus labour and low transportation cost.

 

Weaknesses:

• High dependence on state government grants

Although the share of grants and compensation from the state government has steadily reduced to 25% in fiscal 2023 from 45% in fiscal 2013, it continues to be a major part of the revenue receipts. Since the abolition of octroi in fiscal 2008, the corporation has been consistently receiving compensation from the state government. In fiscal 2023, Rs 774 crore was received as octroi compensation. With rise in property tax and non-tax revenue, dependence on government grants is likely to reduce over the medium term. Additionally, SMC has strong liquidity to partly fund proposed capex in case of delay in receipt of grants.

 

• Large capex requirement

The corporation has large capex planned over the medium term for implementing AMRUT and Smart City schemes, Dumas sea face development project, and barrage projects among others. Estimated project cost under these schemes is around Rs 5,000 crore, spread over five fiscals.

 

Healthy operating surplus is likely to be maintained and no sizeable debt (other than the proposed green municipal bond issuance) will be contracted. However, significant increase in capex, leading to additional debt, could weaken the financial risk profile and will remain a key monitorable.

Liquidity: Superior

Liquidity is strong supported by healthy revenue surplus of around Rs 400 crore per annum over the past five fiscals, and unencumbered cash and bank balance of over Rs 645 crore as on March 31, 2023. SMC is likely to maintain unencumbered cash and bank balance and continue to generate healthy operating surplus to meet debt obligation and partly fund capex.

Outlook: Stable

SMC will continue to generate healthy operating surplus over the medium term while maintaining strong debt protection metrics.

Rating Sensitivity factors

Upward factors:

• Significant improvement in services such as water supply, sewerage and solid waste management
• Increased collection efficiency in existing own-revenue sources and generation of income from additional sources
• Sustained increase in operating surplus over 30%

 

Downward factors:

• Significant decline in collection of property tax
• Fall in operating surplus below 15% on a sustainable basis, weakening the debt protection metrics
• Change in stance of support from the state government in terms of adequacy and timeliness of octroi compensation, and availability of funds under AMRUT and Smart City schemes and other grants
• Adverse change in the payment structure mechanism

Additional disclosures for the provisional rating (for the new bond issuance)

The 'provisional' rating will be converted into a 'final' rating on receipt of the following documents duly executed:

• Escrow agreement
• Representation and warranties letter
• Debenture trustee awareness letter
• Final term sheet

 

Additional documents, if any, executed for the transaction will have to be provided. A rating rationale or report indicating conversion of the 'provisional' rating into the 'final' rating will be published on the CRISIL Ratings website on receipt of the required documents.

 

The provisional rating shall be converted into a final rating after receipt of the transaction documents duly executed within 90 days from the date of issuance of the instrument.

 

The final rating assigned following the conversion shall be consistent with the available documents. In case of non-receipt of the duly executed transaction documents within the above-mentioned timelines, the rating committee of CRISIL Ratings may grant an extension of up to another 90 days, in line with its policy on provisional ratings.

Rating that would have been assigned in the absence of the pending documentation

In the absence of the pending documentation considered while assigning the provisional rating as mentioned earlier, CRISIL Ratings would have assigned a rating of ‘CRISIL AA/Stable’.

Risks associated with the provisional rating:

The 'Provisional' prefix indicates that the rating is contingent on occurrence of certain steps or execution of certain documents by the issuer, as applicable. If the documents received and/or completion of steps deviate significantly from the expectations, CRISIL Ratings may take an appropriate action, including placing the rating on watch or changing the rating/outlook, depending on the status of progress on a case to case basis. In the absence of the pending steps / documentation, the rating on the instrument would not have been assigned ab initio.

About the Company

SMC is one of the largest municipal corporations in Gujarat and is governed by the Bombay Provincial Municipal Corporation Act, 1949, as amended by the government of Gujarat. It has jurisdiction over 462.15 sq km. It provides services such as water supply, sewerage disposal, solid waste management, primary education, public safety, transportation and slum improvement.

Key Financial Indicators

As on / for the period ended March 31	Units	2023	2022
Revenue receipts	Rs crore	3612	3370
Revenue surplus	Rs crore	396	408
Revenue surplus/ revenue receipts	%	11	12

 

Any other information:

For existing bonds:

Broad contours of the escrow structure:

a)      The tenure is five years with half-yearly coupon payment

b)      Bullet/full redemption at the end of five years

c)       Escrow of property tax and user charges collected by and due to SMC-eligible bondholders and lenders shall have first and pari-passu charge over the escrow account, the debt service account (DSA) and the collection account(s).

d)      Establishing separate DSA, DSRA, interest payment account (IPA) and sinking fund account (SFA) with the escrow banker as per the terms of each series. Bondholders/lenders of a particular series have first and pari-passu charge over DSA, DSRA, IPA and SFA for the series.

e)      In case of any shortfall during transfer from the escrow account to DSA, SMC shall compensate with funds from other account(s) to DSA.

 

Interest payment mechanism

T – Interest payment date

Day
T-25	The trustees shall check the amount lying to the credit of IPA. In case of any shortfall in amount, the trustees shall intimate SMC.
T-15	SMC shall make good the shortfall in the IPA, if applicable.
T-14	In case of shortfall, trustees shall trigger the payment mechanism and instruct the bank to transfer the shortfall amount from the DSRA to the IPA.
T-10	The bank shall transfer the shortfall amount, if applicable*.
T	Interest payment is done.

* Any amount drawn from the DSRA should be deposited back in the account

 

Redemption mechanism

T – Redemption date

Day
T-25	The trustees shall check the amount lying to the credit of the SFA. In case of any shortfall in amount, the trustees shall intimate SMC.
T-15	SMC shall make good the shortfall in the SFA.
T	Redemption payment is done.

 

For proposed bonds:

Broad contours of the escrow structure pertaining to the proposed Rs 200 crore bond issue:

a)       All funds as ‘own revenues/cash flows’ here shall mean the revenues/cash flows being directly levied and collected/recovered by the Issuer and not being the revenues/cash flows received from the Government in the form of Grants, contributions & subsidies, compensation in lieu of Octroi or others. The revenues/cash flows being directly levied and collected/recovered by the Issuer include entire tax revenues (i.e. property taxes, profession taxes, water charge, etc), Non Tax Revenues, and other income. Collection accounts(s) shall be transferred to a separate no-lien escrow account for debt servicing. This transfer is done on daily basis.

b)      Eligible bond holders and lenders shall have first and pari passu charge over the escrow account and and the collection account(s).

c)       Total Tenure of 4 years to 5 years with half yearly coupon payment.

Bullet / full redemption at the end of 4 years to 5 years comprising of:-

Sub Series	Tenor (in years)	As %age of issue	Amount (in crore)
A	4	50%	100
B	5	50%	100
Total		100%	200

d)      Establishing separate DSA, DSRA, interest payment accounts (IPA), and sinking fund accounts (SFA) with the escrow banker as per the terms of each series. Bondholders/lenders of a particular series have first and pari-passu charge over DSA, DSRA, IPA, and SFA for the respective series.

e)       In case of any shortfall during transfer from the escrow account to DSA, SMC shall compensate with funds from other account(s) to DSA.

f)        The principal amount of the debentures to be issued with all the coupon due on the debentures, as well as costs, charges, all fees, remuneration of the debenture trustee and expenses payable in respect thereof has been secured by way of exclusive first ranking floating charge over present and future receivables pertaining to its own revenue/ cash flow

 

Interest payment mechanism

T – Interest payment date

Day
T-25	The trustees shall check the amount lying to the credit of IPA. In case of any shortfall in amount, the trustees shall intimate SMC
T-10	SMC shall make good the shortfall in the IPA, if applicable
T-9	In case of shortfall, trustees shall trigger the payment mechanism and instruct the bank to transfer the shortfall amount from the DSRA to the IPA
T-8	The bank shall transfer the shortfall amount, if applicable*
T	Interest payment is done

* Any amount drawn from the DSRA should be deposited back in the account

 

DSRA

Day
T-7	DSRA amount will be used to make the coupon payment in case of shortfall
-	The issuer shall make good the DSRA amount shortfall within next 15 days (T+8). Furthermore, immediately after the DSRA utilisation, the amounts lying or credited in the escrow account shall flow into the IPA for DSRA replenishment and shall not be transferred by the issuer to the general fund account(s) till the time the required DSRA amount is replenished.

 

Redemption mechanism

T – Redemption date

Day
T-45	The trustees shall check the amount lying to the credit of the SFA. In case of any shortfall in amount, the trustees shall intimate SMC
T-15	SMC shall make good the shortfall in the SFA
T	Redemption payment in done

 

Annexure - Details of Instrument(s)

ISIN	Type of instrument	Date of allotment	Coupon Rate (%)	Maturity date	Issue size (Rs crore)	Complexity level	Rating assigned with outlook
INE05NX24015	Taxable bonds	01-Mar-19	8.68%	01-Mar-24	200	Simple	CRISIL AA+/Stable
NA	Green municipal bond*	NA	NA	NA	200	Simple	Provisional CRISIL AA+/Stable

*yet to be issued