WATER AND SANITATION PROGRAM: Learning note 64710 Sustainable Services for Domestic Private Sector Participation Key findings Using Credit Ratings to • Cost recovery tariff policies Improve Water Utility Access create opportunities for water utilities to access medium-term commercial debt to finance to Market Finance in Sub- capital investments with positive return. Saharan Africa • Credit ratings can support February 2012 investment-grade utilities to access finance from domestic markets, as they give lenders INTRODUCTION PROBLEM STATEMENT an objective overview of risk. Despite considerable public investment in In spite of considerable liquidity within They also allow utilities to water supply, access to services in sub- the private financial sector, banks identify areas for improvement Saharan Africa remains low. In Kenya have been reluctant to lend to water and to exchange good for example, urban water utilities provide utilities for a number of reasons: practices. services to 40 percent of the urban • Water is often viewed as a social • Public finance and grants population.1 Access to finance is often a good with little ability to generate should be leveraged to attract key constraint to extending coverage to un- financial return investment from domestic served consumers, especially as utilities have traditionally relied on government and • Banks in sub-Saharan Africa do financial markets. This leverage development partners to finance capital not lend for periods beyond seven can help increase the overall investments. These resources are limited to ten years, whereas the useful investment potential, reduce and the additional investment needs are life of water assets is often much risk to commercial lenders, and too large to be funded from public sources longer allow for a rational allocation and utility surplus revenues alone. Yet of public funds to pro-poor • Water assets provide only limited investments made in the extension and projects. collateral to lenders because they rehabilitation of distribution networks can have little liquidation value often generate financial returns to cover • Utilities must take the lead • Utilities, due to limited commercial in identifying and preparing the investment costs where cost recovery borrowing occurring in the sector, viable projects for appraisal tariffs are employed to cover operating and are often not conversant with the by commercial lenders, and maintenance (O&M), capital investment, lending criteria of commercial seek the necessary internal and debt service costs. Furthermore, banks approvals to borrow. developments in financial markets provide opportunities for utilities to access As a result, the creditworthiness of medium-term commercial debt to finance water utilities and their investment investments with positive return. projects is often opaque to borrowers and lenders alike. 1 Water Services Regulatory Board coverage data for 62 urban utilities 2009-10 (8.1 million people with access in population area of 20.5 million); as cited in IMPACT Report, Issue no. 4 (2011). Available online: http://www. wasreb.go.ke/images/stories/documents/WASREB_Impact_Report4.pdf 2 Using Credit Ratings to Improve Water Utility Access to Market Finance in Sub-Saharan Africa ACTION Box 1: Utility Projects Accessing Medium-Term Since 2007, the Water and Sanitation Program (WSP), with Commercial Finance in Kenya support from the Public Private Infrastructure Advisory Facility (PPIAF), has been working with utilities to improve access to The International Finance Corporation is currently appraising market finance. As a result of this partnership, a mechanism to two water and sewerage projects, developed with support assess utility creditworthiness was developed. The mechanism from WSP and PPIAF, for ten-year domestic currency loans at rates utilities according to internal factors, such as financial and market interest rates. Malindi Water (BBB-rated) is seeking to raise US$4 million to undertake a service coverage expansion credit management, management quality and capacity, and project targeting 103,000 residents. The International operational performance. It also measures external factors, Development Agency is supporting the project with a including economic base, susceptibility to external shocks, concessional loan of US$2 million. Embu Water (BB-rated) and changes in sector policy. Seven utilities in Senegal, is seeking to raise US$3 million to finance a sewer network Tunisia, Burkina Faso, Uganda and Kenya were assessed and and treatment works to serve 40,000 people. In addition to assigned credit ratings in December 2008. On a domestic project revenues, investment in Embu’s water supply financed scale, where the government of the country of operation is by external partners will help the utility generate sufficient AAA-rated, the utilities were assigned investmentgrade ratings cash to repay the loan. The rating process helped identify from BBB to A+2 as shown in Table 1. management and operational weaknesses to be addressed as part of the proposed lending. The projects are critical in In 2011, WSP, in collaboration with the Water Services demonstrating the ability to leverage concessional finance to Regulatory Board (WASREB), launched a credit assessment access commercial debt. of 43 utilities in Kenya using a similar methodology and assigned shadow credit ratings. Shadow ratings are primarily used for diagnostic purposes and to test how financiers might evaluate a company’s credit standing. The assessment resulted in thirteen utilities receiving an A or BBB rating KEY LESSONS (considered creditworthy) and another sixteen receiving a BB Key factors that impact utility creditworthiness rating (potentially creditworthy) as shown in Figure 1. Fourteen The following factors were key in assigning investment- utilities in the “No Rating� category have difficulty remaining grade credit ratings: Cost recovery tariff policies, annual solvent and require substantial reforms before financial tariff indexation (Uganda), low distribution losses (Senegal, markets will advance them debt finance. One BBB-rated and Tunisia and Burkina Faso), and low existing levels of debt one BB-rated utility are currently seeking commercial finance (Kenya, Uganda and Senegal). Significantly, utilities with better for infrastructure projects, as discussed in Box 1. Table 1: Ratings Assigned by Global Credit Rating Company to Seven African Water Utilities Name Short term rating Long term rating Athi Water Services Board A2 BBB+ Nairobi City Water and Sewerage Company A3 BBB National Water and Sewerage Corporation A2 A Office National de L’eau et de L’assainissement (ONEA) A2 BBB+ Sénégalaise des Eaux (SDE) n.a n.a Société Nationale des Eaux du Sénégal (SONES) A1 A+ Société Nationale d’Exploitation et de Distribution des Eaux (SONEDE) A1- A 2 Investment grade is ≥ BBB- www.wsp.org Using Credit Ratings to Improve Water Utility Access to Market Finance in Sub-Saharan Africa 3 Figure 1: Shadow Credit Rating of Kenyan Water Utilities KEY 35% – 44% = BB 45% – 59% = BBB 60% – 69% = A A letter rating is assigned according to the aggregate percentage scored by the utility using the Water Credit Assessment Tool ratings had lower non-revenue water and higher metering and from development partners should be leveraged to attract operating cost coverage ratios. investment from domestic financial markets. Notably, utilities in both sets of credit assessments were not A flexible loan security structure can be adopted by assigned high ratings typically associated with being virtual lenders monopoly providers of an essential good, as they face some challenges, amongst which are: low surplus cash to Lenders are interested in securing cash flow from borrowers’ fund capital expenditure; poor working capital management projects. Therefore, projects that demonstrate sufficient debt exacerbated by significant delays in collecting receivables; service cover secured by a loan structure — that provides the apparent weaknesses in management systems; and slow lender with first right to residual cash after essential operating implementation of full cost recovery policies. costs have been met — may be used to secure debt finance. A legal and regulatory framework that supports financially Investments should be sized to fit the debt capacity sound autonomous utilities is therefore essential. When using commercial debt to finance infrastructure, capital Utilities must take the lead in identifying and developing investment plans should fit the debt absorption capacity of the viable projects for financing borrower. Lenders will normally require a debt service cover ratio of between 1.5 and 2 to cover risks arising from shocks Ideal projects for commercial financing will generate sufficient and changes in input costs.3 Utilities borrowing from the market revenue to repay the debt used to finance them. These are will need to consider scaling back or phasing investments to likely to be tertiary investments in network densification and match the financial resource envelope. expansion, metering, non-revenue water reduction, energy efficient investments, and non-capital intensive source Commercial debt should be blended with financial support augmentation and treatment. from the public sector The ability of utilities to raise all the financial resources needed for investment is very limited, hence public finance and grants 3 Debt Service Cover Ratio is generally calculated as: Net cash after operating and maintenance expenditure and tax/debt service (principal + interest). www.wsp.org 4 Using Credit Ratings to Improve Water Utility Access to Market Finance in Sub-Saharan Africa CONCLUSION opportunities for utilities to access Acknowledgements domestic credit on commercial terms, Encouraging creditworthy utilities to About the author: especially as banks now see the water finance a portion of their investment Rajesh Advani is a Finance Specialist sector as a potential partner, where they program using commercial debt will with the Water and Sanitation had previously perceived it as high risk. improve the allocation of public funds Program and is based in Nairobi, Additionally, benchmarking through for investment. Budget allocations, Kenya. He has been working on credit ratings provides opportunities for projects to improve utility access grants, and concessional loans from utilities to identify areas for improvement to market finance, leverage public development partners can be freed up and to exchange good practices, and funds and grants for infrastructure for non-commercially viable investments, investment in urban and rural water it can also support regulatory efforts such as water resource development, supply, and develop small scale to improve sector governance and storage, treatment, and expansion into PPPs. planning. Taking steps to address areas where poor consumers cannot performance issues that hinder access Peer reviewers: Alexander Bakalian, afford cost recovery tariffs. Commercial to credit could see significantly more Jeffrey Delmon, Laura Vecvagare, debt also brings governance benefits Jemima Sy (World Bank Group) investment in water by the private in the form of additional oversight sector, resulting in improved access in from lenders that help utilities improve capital expenditure planning, operating urban areas. About the project With an estimated US$26 billion efficiency, and financial management. needed between 2005 and 2014 The management teams of creditworthy RELATED READING to reach the MDGs in water and utilities need to take up the challenge sanitation, WSP is working to of preparing projects for financing and WASREB/WSP. Financing Urban Water leverage domestic private sector seeking support from their boards Services in Kenya – Utility Shadow expertise and resources to deliver of directors to borrow. Technical Credit Ratings. Nairobi: WASREB/WSP, services that benefit the poor. The assistance to support deal structuring November 2011. aim is to help an estimated 1.5 million poor people gain sustained and development of bankable projects Global Credit Rating Company. African access to improved water supply is essential in the early stages of Water Utilities Regional Comparative and sanitation services and leverage developing commercial infrastructure Utility Creditworthiness Assessment over US$80 million in investments financing concepts. Report. Nairobi: WSP/PPIAF, December by donors, governments, and the 2008. domestic private sector through three Looking forward, the credit rating main activity lines: building water and exercises are expected to open sanitation business models for the poor; Public-Private Partnerships in non-traditional markets; and, banking the unbanked water and sanitation ABOUT WSP providers. For more information, WSP is a multi-donor partnership created in 1978 and administered by the World Bank to support please visit www.wsp.org. poor people in obtaining affordable, safe, and sustainable access to water and sanitation services. WSP’s donors include Australia, Austria, Canada, Denmark, Finland, France, the Bill & Melinda Gates Foundation, Ireland, Luxembourg, Netherlands, Norway, Sweden, Switzerland, United Kingdom, United States, and the World Bank. WSP reports are published to communicate the results of WSP’s work to the development community. Contact us The findings, interpretations, and conclusions expressed herein are entirely those of the author and For more information please visit should not be attributed to the World Bank or its affiliated organizations, or to members of the Board of www.wsp.org or email Rajesh Advani Executive Directors of the World Bank or the governments they represent. at wspaf@worldbank.org. © 2012 Water and Sanitation Program www.wsp.org