Muni-Bonds Come Of Age

With Ahmedabad Municipal Corporation (AMC) set to tap the debt market, way is paved for other corporations to take the plunge.

A couple of years ago, few savvy investors would have thought of investing in the debt instrument of a municipal corporation. You couldnt blame them. Municipal corporations are better known as the epitome of financial inefficiency.

One municipal corporation that has managed to break free of the traditional image and gain investors confidence is the Ahmedabad Municipal Corporation (AMC). It is the first municipal corporation in Asia to get its bonds rated, and the second to raise money through such bonds (the first being the municipal corporation of Shanghai, China).

 

The AMC proposes to issue one million secured redeemable bonds of the face value of Rs 1,000 each, totalling Rs 100 crore with a greenshoe option of Rs 50 crore. It has already allotted bonds of Rs 75 crore on to institutions while the retail subscription for remaining Rs 25 crore is scheduled to open later this month. If the AMC issue goes through smoothly, particularly in the retail segment, it will make way for at least some other municipal corporations to follow suit. As things stand, at least six other bodies have already been rated and four more are believed to be under review. Analysts are anxiously watching the scene, because if successful, this experiment could open up not only a vast new area of funds for municipal corporations but also good amount of business for merchant bankers and other intermediaries. Optimism is abundant, with some experts estimating the size of the potential market at a massive Rs 8,000 crore. But tapping the market is not going to be easy, particularly for the initial entrants. The AMC had to address what it saw as problem areas for the investors before taking the plunge.

Municipal finances

Traditionally in India municipal corporations have relied on government grants, privately placed debt paper with banks (backed by a state government guarantee) and internal generations for funding their activities. But the bottomline was that these were essentially wholesale sources. Internationally (especially in the US) though, municipal bonds (or muni bonds) cater to a mostly retail kind of market given the fact that these bonds carry attractive tax benefits for the individual investor. This is exactly the type of culture that USAID and financial institution reforms and expansion (FIRE) project wanted to bring into India which is why the idea of doing a public issue came into being. USAID in fact has granted an in - principle commitment of $ 25 million for the project under its Housing Guarantee Programme.

If the investors thus far had not shown any enthusiasm for such bonds, it was because of the belief that a quasi government body could hardly be expected to run the organisation, leave alone profitably, even on a break-even basis. The weak finances of municipal bodies are aggravated by the fact that their financial health is shrouded in mystery, given their single entry accounting system.

The AMC has gone all out to change this image first by generating positive revenues over the last four years with the closing balance for the year 1996 - 97 being Rs 78.24 crore. A measure of its efficiency can also be seen from the fact that it has been rated 'AA (SO)' by CRISIL indicating high safety for timely payment of interest and principal in spite of the fact that it does not have a state guarantee. To attract the retail segment it has also priced the issue attractively (for the investor) at 15 per cent. With interest payable semi annually, the yield works out to 15.56 per cent. Another noteworthy feature for retail investors is that the firm allotment of Rs 75 crore to institutional investors - provident funds, cooperatives, public trusts, commercial banks, financial institutions and mutual funds - has already been completed. This would to an extent provide a comfort level for the investor who was earlier not very confident of the wisdom of such an investment. And finally, the bonds would be

listed on Ahmedabad and NSE, to take care of the secondary market liquidity problem.

As a part of the investor protection mechanism the issue has a structured obligation in place with an escrow account for which IL&FS has been nominated as the trustees. The corporation has identified 10 octroi collection points that have been designated for the escrow account where the daily collections will be deposited and kept in safe custody.

And finally, the AMC is toying with the idea of abandoning the single entry system of accounting and opting for the more professional system of double entry. This will allow investors to gauge its financial soundness better.

The risk factors

The corporation expects the bonds to be serviced and repaid from the general revenues of the corporation. An analysis of the revenues of the corporation reveals that octroi funds account for almost 70 per cent of the total tax revenue with property tax being the other major source. Merchant bankers to the issue - IL&FS, ANZ Grindlays and SBI Capital Markets - are apprehensive that any move to abolish octroi could jeopardise the entire escrow account mechanism.

This possibility, however, does not seem realistic. According to Naval Bir Kumar, deputy - head capital markets, ANZ Investment Bank, "Since the government is increasingly trying to disengage itself from funding these corporations, the possibility of obliterating a major source of revenue seems bleak." And even if octroi is abolished it could be substituted by a similar revenue generating source. Market players cite the example of Madhya Pradesh where octroi was abolished but had to be reintroduced in a different form because of various fiscal problems that the corporations had to face.

To strengthen its financial base, AMC has taken various steps which would improve octroi assessment and compliance: it has installed weighing machines, increased surveillance, deployed additional police personnel and set up a market research wing to update the assessment procedures. This has already borne fruit: annual collection has already gone up from Rs 122.89 crore in 1992 - 93 to Rs 224.92 crore in 1996 - 97 which is a growth of 83.03 per cent.

The other major problem is the project itself. The project is divided into two parts. The first part comprises the development of an alternate water access arrangement for the city, though its details are not worked out yet. The creation of such a source would also entail additional water treatment plants, construction of infrastructure for storage and distribution and augmentation of the existing system.

The second part is a two phase plan to develop a sewage collection, treatment and disposal system in the eastern suburban area of Ahmedabad (the project cost of Rs 489 crore has not been appraised by any external agency, however). Since municipal bodies in India are at the mercy of state governments for their working, there is a large degree of political interference. Does this make the investors wary? No, say players. There are two reasons for their opinion. First, because most subscribers to these bonds are expected to be the residents of Ahmedabad and Gujarat who are prima facie also the major vote banks for the state government, no measures are expected that may adversely affect the project. Secondly a recent amendment to the BPMC Act limits the period of supersession of any municipal corporation by the state government to a maximum of six months.

The lead managers are pretty bullish about the issue. "We are flooded with requests for allotment from institutions, totalling Rs 79 crore, says R.K. Mehta, executive director, SBI Capital markets. Even the retail portion is expected to evoke good demand, he adds. Interestingly, lead managers are so confident about the retail issue that they have underwritten the full amount of Rs 25 crore. Whether the AMC bond issue will lead to the opening up of the market for municipal corporations will depend on the efficiency of these bodies and the confidence they could inspire among the investors. And for that, the corporations will have to adopt innovations in their finances.