Accessing Credit Ratings for Development of Sub-National Governments of Nigeria

Accessing Credit Ratings for Accessing Credit Ratings for Development of Sub-National Development of Sub-National

Governments of NigeriaGovernments of Nigeria

World Bank Engagement with World Bank Engagement with Sub-National Entities Sub-National Entities

ABUJA, NIGERIAMarch 2009

STEVEN DIMITRIYEVSenior Finance and Private Sector Development

SpecialistNigeria Country Office

Email: [email protected]

PIDG, November 9th, 2006

Political and fiscal decentralizationPolitical and fiscal decentralization

Deepening of “DEMOCRATIZATION” pushes “DECENTRALIZATION”

transfers taxing authority as well as investment responsibilities to local governments.

makes local public officials and administrations accountable for public service provision (infrastructure as well as social services).

Today, 60% to 70% of infrastructure services in developing countries is provided at the sub-national level (by local governments or utilities) /1.

/1 World Bank staff estimates


Sub-national development Sub-national development challengeschallengesIn order to fulfill their development role, sub-nationals In order to fulfill their development role, sub-nationals will need to address fiscal, institutional and financial will need to address fiscal, institutional and financial

challenges.challenges.

Fiscal constraints at the central government level

Competition for funds (i.e. safety networks and security) and reduction of counter-guarantees available to sub-nationals

Legal and regulatory frameworks for sub-national borrowing

Limited access of sub-nationals to domestic capital markets

Creditworthiness of sub-national

Reduced access to long-term funding for infrastructure investments

Development condition of local financial markets

Shallow markets unable to respond to the needs of sub-nationals (maturities and interest rates)

Challenges Limitations


Decentralization without addressing the fiscal, Decentralization without addressing the fiscal, institutional and financing challenges is creating a institutional and financing challenges is creating a

service provision dilemma.service provision dilemma.

Sub-national infrastructure service provision Sub-national infrastructure service provision dilemmadilemma

Central Government w/

fiscal constraints

Central Government w/

fiscal constraints

Sub-nationals with low

creditworthiness

Sub-nationals with low

creditworthiness

Reduced CAPEX and

maintenance expenses

Non-willingness to pay from end-users

Lack of growth / deterioration of service quality

Poor service delivery

Competition from other uses (social safety network, security, etc.)

Less funding

Unable to Unable to meet MDGmeet MDG

Lack of access to financial markets


Public Financial Management (i.e., tax planning, tax collection and administration, revenue and expenditure management, information systems, asset management, debt management systems, etc.)

Infrastructure Regulatory Framework (i.e., tariff setting, tariff collection, subsidies policies, sector regulation, private sector role, investment planning, etc.)

Corporate Governance (i.e., procurement process, safeguards, monitoring and reporting systems, audited financial statements, credit ratings, etc.)

Financial Regulatory Framework (i.e., debt regulation for sub-national borrowing -- fiscal responsibility legislation, monitoring and reporting to central government, capital market regulation, bankruptcy and legal claims against sub-national entities, etc.)

Capacity Building (i.e., training, staffing, incentives, etc.)

Breaking the infrastructure Breaking the infrastructure dilemmadilemma

Must create Must create FINANCIALLY INDEPENDENT SUB-NATIONAL FINANCIALLY INDEPENDENT SUB-NATIONAL ENTITIESENTITIES

capable of delivering infrastructure and public goods. capable of delivering infrastructure and public goods.


Sub-National Investment Climate

WBG seeks REFORM SYNERGIES: Bank regulation, Sub-national credit market

development, Pension reforms, Fiscal Responsibility Act…

Investment Climate Program (ICP), FSS2020, PPPI….

CREDIT RATING impacts on the cost of capital borrowed,

On economic viability of INVESTMENT PROJECTS

On assessment of INVESTMENT CLIMATE


Current WBG sub-national effortsCurrent WBG sub-national efforts

IBRD / IDA requires a sovereign guarantee – or lends to the central government which on-lends to sub-nationals Two types of loans:

• Investment (e.g. PPP, public works…)

• Budget Support (policy development/implementation, debt reduction…)

For IBRD loans, a Credit Rating is also normally expected IFC – can lend without sovereign guaranteee but mainly to

private sector, or to mobilize additional private capital (e.g. via guarantees).

High focus on improving the Sub-national Investment Climate in Nigeria

The World Bank and IFC lends to sub-nationals for The World Bank and IFC lends to sub-nationals for infrastructure investment under two different infrastructure investment under two different

approaches. approaches.


IFC sub-national experienceIFC sub-national experience

Project Type ExposureTotal

Financing

Leverage

Ratio

City of Johannesburg, SA

Local government

30.0 150.0 5

Guatemala CityLocal Government

6.5 43.0 6

Buffalo City, SALocal government

8.0 30.0 3

Tlalnepaltla, MexicoMunicipal

water utility

3.0 9.0 3

Guangzhou Development Industry Holdings

Provincial utility 50.0 288.0 6

Protego SOFOL/1 Financial Intermediary

2.5 50.0 20

Total 100.0 570.0 5/1 Equity related product

The Municipal Fund has effectively mobilized additional private capital financing for its sub-national

clients. Selected IFC Transactions – Exposure and leverage


Sub-National Entities – Transition to Sub-National Entities – Transition to Market AccessMarket Access

Three main market segments:

States, Provinces and other political subdivisions

Infrastructure parastatals and utilities

Development finance institutions and other financial intermediaries that are financing sub-national entities

World Bank IBRD/IDA Lending and Capacity Building

(with Sovereign Guarantee)

Sub-National Lending (without Sovereign Guarantee)

Private Capital Market Access (on own Credit)

Time

Cre

dit

wo

rth

ine

ss


Tier 2: Market Access with Credit Support

Tier 1: Market Access on Own Credit

Tier 4: Limited Financial Transparency

Tier 3: Audited Financials

IDA countries w/ weak legal and regulatory

frameworks

IDA and middle income countries w/ strong

legal / regulatory frameworks

Middle income countries with strong legal and regulatory

frameworks and developed local capital

markets

Sub-national Entities – 4 Tiers Sub-national Entities – 4 Tiers (Goal is raise from lower to higher (Goal is raise from lower to higher tiers)tiers)

• Local GovernmentsLocal Governments• Public UtilitiesPublic Utilities• DFISDFIS


Sub-National Sub-National Clients: Clients: India India (for illustration)(for illustration)

India requires US$ 25 bn a year to fund its infrastructure needs. Commercial bank lending to infrastructure in 2003 was US$ 5.9 bn. The annual funding requirements for urban infrastructure alone amount to US$ 8.3 bn of which only US$ 1.1 bn is covered through Central Plan outlays

Of the approx. 3,700 Urban Local Bodies, only 50 are creditworthy enough to access domestic capital markets. Government transfers finance more than 40 percent of consolidated local expenditures. 10 municipalities have accessed capital markets through 13 bond issues o/w 10 have been placed without govt. guarantees at interest rates of 7% to 14%

Pooled finance mechanisms being created to fund small and medium city infrastructure projects e.g TNUDF, KUIDFC. 35 of 3,700 ULBs, 100 parastatals, 7 of 21 of State Industrial Development Corps., and 2 of 18 State Financial Corps. have local currency credit ratings

Urban Local Bodies = 10DFIs = 4State Financial Corporations = 2State Ind. Devt.Corporations = 7Parastatals = 100

Urban Local Bodies = 3 Infra. Parastatals = 13 Market Access with Credit Support

Market Access on Own Credit

Limited financial transparency

Audited Financials

Ra

ng

e o

f S

ub

-Na

tio

na

l C

lie

nts

Municipalities = 10 bond issues

Urban Local Bodies = 3,690State Financial Corporations = 16State Ind.l Dev.t Corp = 21Specialized Finance Institutions = 4 Parastatals = 141


Mexico began to implement major decentralization reforms in the late 1990s

•Made national/ subnational transfer system more transparent and predictable

In 1999, Mexican government wanted to address the problem of subnational bailouts:

•Cause: use of national/subnational automatic transfers (mandatos) as loan guarantees

Mandato guarantees made loans to subnationals virtually risk freemoral hazard for banks over borrowing by subnationalsbailouts

•Ineffective national government controls on subnational borrowing


To address these issues, the Mexican Government asked for assistance in developing a market based system

•This led to the World Bank’s Decentralization Adjustment Loan of about US$600 million

•Dexia Credit Local participated in the loan’s preparation

Focus on modernizing the regulatory framework for subnational lending

Some key reforms:

•Elimination of the mandatos•Requirement for credit ratings for all

subnationals for bank borrowing


The credit ratings revealed that there are many creditworthy borrowers at the subnational level

•30 out of 31 states are already rated by S&P, Moody’s or Fitch (29 above investment grade on the local scale)

•Over 60 municipalities and decentralized entities already been rated

Of a total of 75 states and municipalities rated by S & P, 50 received a rating of A or above on the local scale

Ratings have also created a healthy competition among states and municipalities

•Mayors and governors pride themselves on having better ratings


Demand for local currency, fixed-income paper growing rapidly due to:

• Macroeconomic stability• Mutual funds• Pension reform of 1997

The 1997 pension reform created the private managers of mandatory pension funds: Afores

•In five years, these Afores:Have accumulated assets in excess of 8% of GDP (US$34 billion as of April 2003)

Are expected to reach 20% of GDP by 2015


Two Windows – Two Windows – To strengthen institutional capacities and independent access to private financial markets (financial support via co-lending or guarantees).

Technical Assistance Window

Financing Window

Loans in local currency (subject to market conditions cross-border financing may be provided); use of guarantees

Use of guarantees and derivatives to leverage local financial markets

Capacity

strengthening technical assistance

Upstream transactions and

market development

Project facilitation

Project facilitation

Tier 4

Tier 3

Tier 2

Tier 1Tier 1

Technical assistanceTechnical assistance to strengthen sub-national financial and operational management and governance systems (with other reforms (ICP, FSS2020, PPPI…)Financial support to facilitate development of local markets and mobilize private capital for infrastructure financing (leverage 5:1)


Public Private Infrastructure Facility (PPIAF)

• Multi-donor facility with 14 donors

• Established 1999

• Annual budget of $20 million

• 50% of portfolio is in Africa

• Total Portfolio Value of $115 million

• Provides grants (not loans) to support upstream work with Governments to facilitate access to private sector financing and the creation of public private partnerships

• Investments are used to support infrastructure development

• Recently opened a new Sub-National Grant Facility to specifically assist local authorities to access domestic credit

• Can also work with State Owned Enterprises and Municipal Utilities

• Managed by the World Bank


PPIAF Operating Characteristics

• Demand-driven model. Local Authorities apply for grant resources.

• Application and draft Terms of Reference for Assistance is all that is required

• Focus on infrastructure, but includes municipal financing

• Activities not tied to specific financiers or financing options

• 50% of grants under $75,000 but can be higher

• Approval process 3 to 8 weeks depending on size of grant

• Website: www.ppiaf.org

• Email: [email protected]

• Contact Abuja office of World Bank (e.g. email shown on title page of this presentation)

http://www.ppiaf.org/

mailto:[email protected]


• Financial Management: credit ratings (shadow ratings, advisory services…), tax planning, tax collection and administration, revenue and expenditure management, information systems, asset management, debt management systems, etc.

• Infrastructure Management: tariff setting, tariff collection, subsidies policies, sector regulation, private sector role, investment planning, etc.

• Corporate Governance: procurement process, monitoring and reporting systems, audited financial statements, etc.

• Regulatory Frameworks: debt regulation for sub-national borrowing -- fiscal responsibility legislation, monitoring and reporting to central government, capital market regulation, bankruptcy and legal claims against sub-national entities, etc.

• HR issues: training, staffing, incentives, etc.

Examples of Types of Activities under PPIAF Sub-National Program


Examples of Approved Grants

Swaziland ($320,000): Assistance to help two cities borrow from local banks to fund slum upgrading and related infrastructure improvements.

Africa Regional ($315,000): TA to assist 6-8 water utilities obtain shadow credit rating; creditworthy utilities may go on to formal ratings and financings.

Ningbo City, China ($75,000): In-country training on municipal financing options. Ningbo first city in China authorized to borrow on own account

Philippines ($45,000): Assistance to small water providers and potential lenders to bring them together on specific financing transactions.

LGU Financing Framework in the Philippines

Kamran M. Khan

Infrastructure Finance Advisor

East Asia and the Pacific Region, the World Bank

October 11, 2008

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Agenda

1. LGU segmentation by credit quality

2. Financing options for Tier 1 LGUs

3. Innovative financing of tier 2-3 LGUs via GFI

4. Performance grants and tier 4 LGUs

5. Disaster Risk Management for LGUs


LGU segmentation by credit quality C

red

it Q

ual

ity

LGU Income Class

Key Financing Options

Grant / MDFO MDFO/GFI Bonds, Pvt Credit

Credit-worthyand able to tap

the market

Credit-worthybut unable to tap

the market

MarginallyCredit-worthy

NotCredit-worthy

Financially Weakest6th Income Class

Financially Strongest1st Income Class

Tier 4

Tier 3

Tier 2

Tier 1

30%

20%

45%

5%

Source: World Bank Estimates


Tier 1 LGUs should be encouraged to tap the market

Pilot transitions are necessary to jump-start the private financing market

Credit Rating Program for LGUs

• WBG to establish the model for lending to LGUs based on the strength of their credit (i.e., without guarantees)

• Pilot transaction involving a direct WBG fixed rate, local currency loan to Marikina City + TA on financial planning

• Focus on showing the way to the private banks and GFI to engage in credit-based lending to LGUs

• Establish benchmarks for LGU credit• Quezon, Baguio, Naga and many

others have expressed interest

• WBG open to co-financing with private banks and GFIs

• World Bank and LCP Partnership financed with WB and PPIAF SNT support

• Credit Rating of 8 LGUs (FY’09 -Phase I)

• Global and local benchmarks

• Extended FM Assessment

• Standard and Poor’s selected; work to commence next week (October 2008)

• Participating LGUs to pay for the renewal of the rating for at least 1 year

• Showcase the results at the Annual Conference of the WB – ASEAN Infrastructure Finance Network

World Bank Group Sub-national Finance


WB and GFIs can explore innovative models for financing tier 2-3 LGUs

GFI-based World Bank funded facility designed to buy loans made by private banks to credit-worthy LGUs Bridge the gap between GFIs and private banks Provide liquidity to private banks for LGU financing

LGU financing of municipal infrastructure PPPs GFI-based WB funds used for the public sector contribution to

PPPs Associated TA fund to help LGUs prepare bankable projects

Credit enhancement to help GFI securitize their LGU loan portfolio Provide liquidity to the GFIs Benchmark GFI credit analysis capacity


Performance incentives are the key to the reform of tier 4 LGUs

LGU Receipts as a % share of GNP

0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

3.0%

3.5%

4.0%

1991 1993 1995 1997 1999 2001 2003 2005 2007

Total LGUReceipts

IRA

Other LGUReceipts

Source: East Asia Energy Unit, The World Bank

• Incentive payments for pre-defined measurable performance improvements

• Financial performance• Operational performance• Planning and budgeting

• LGU must meet the basic performance targets to remain in the program

• Better use of IRA and OSA thorugh improved LGU performance

• Link with the GOP LGU performance

systems, e.g., Local Government Performance Monitoring System, Bureau of Local Government Finance indicators

Estimated Total IRA per Capita (COA & Census), Constant 1985 Prices

0

50

100

150

200

250

300

1992 1995 2000 2007

…and remained constant on a per capita basis

IRA has declined slightly as a share of GNP …


Disaster Risk Management (DRM) remains a key priority for the LGUs

Philipines faces a high degree of natural disaster risk Between 1990-1996 an estimated $480 mil in losses per year

(0.5% of GDP) Average of 1,009 lives are lost every year due to natural

disasters

Strategic, comprehensive approach to DRM

Map, quantify and model the risk Anticipate the low risk, high probablity events Identify the high risk, low probability events

Layer and match the risk + the mitigation strategy + financial instrument Technical Assistance available through WB and other donors

Consider a comprehensive set of financial instruments Establish the framework for disbursing funds to “qualified”

LGUs


DRM financing framework

Source: Financial and Private Sector Development/ Financial Markets Networks World Bank, 2008

Reserves

Contingent Loans

Insurance/Reinsurance

Insurance Linked Securities (e.g., CAT bonds)

Ret

entio

nR

isk

Tra

nsfe

r

Probability InstrumentSeverity

Low

High

High

Low


DRM financing products

The Catastrophe Risk DDO or CAT DDO provides immediate liquidity upon the occurrence of a natural catastrophe. They offer bridge financing while other sources of funding are being mobilized.

Deferred Drawdown Option

(DDO) Loans

The World Bank Group is developing a multi-country catastrophe bond that would pool the risks of several countries and transfer it to capital markets..

Insurance-Linked Securities

Risk T

ransfer

Risk

Reten

tion

Weather Derivatives

The World Bank Group offers weather derivatives to provide risk management products to member countries, transferring the weather risk to the market.


Recent DRM financing transactions

First CAT DDO (Costa Rica) approved in September 2008.

Deferred Drawdown

Option (DDO) Loans

Platform for the multi-country catastrophe bond is under development.

Insurance-Linked

Securities

Risk T

ransfer

Risk

Reten

tion

Weather Derivatives

First weather derivative (Malawi) executed in October 2008.

Documents

Accessing Credit Ratings for Development of Sub-National Governments of Nigeria