Moody's de Mexico has assigned ratings of Aa2.mx (Mexico National Scale Rating) and Baa3 (Global Scale, Local Currency) to the State of Mexico's MXN 1.778 billion Municipal Lending Program. RATINGS RATIONALE Within this program, Banobras, the lender, will grant individual loans to municipalities joining the program, which will be paid by a trust (IXE Bank F/796 as trustee) that will receive earmarked federal transfers from the Municipal Social Infrastructure Fund (FAISM). The state of Mexico is the originator of the municipal trust and has instructed via an irrevocable instruction to the Federal Treasury (TESOFE), to transfer FAISM revenues directly to the trust. Municipalities that access the lending program will sign individual loan agreements with Banobras and adhere to the trust agreement. The loans will carry a fixed interest rate and the maximum maturity will coincide with the end of current municipal administrations ( November 2015 ). The amount of each loan will vary according to the FAISM amount available when each loan contract is signed. Accordingly, the global amount under the lending program was estimated to reach up to MXN 1.778 billion. The ratings assigned are based on documentation received by Moody's as of the rating assignment date. While individual loan contracts within the program will be signed during the life of the program, Moody's does not expect changes to the structure over this period. In the event that the program structure changes from the documentation submitted to us, Moody's will assess the impact that these differences may have on the ratings and act accordingly. The Baa3/Aa2.mx ratings assigned to the lending program reflect the underlying creditworthiness of the State of Mexico (Ba2/A2.mx, stable) supported by the following legal and credit enhancements: - Trust structure and the irrevocable instruction to TESOFE reduce the probability of a municipality interfering with the flow of funds. Furthermore, the earmarked nature of FAISM, which can only be used for capital projects and up to 25% for debt service, greatly limits the incentive for municipalities to attempt to divert these flows, in the event of a crisis, to cover current expenditures. - In contrast to participation transfers, which are vulnerable to economic fluctuations, FAISM transfers are more stable and less exposed to volatility. Specifically, the exact level of annual FAISM transfers is fixed each year in the federal budget. - Moreover, the Fiscal Coordination Law establishes that the amount of FAISM transfers available to municipalities for debt service is the greater of either 25% of FAISM transfers in any given year or 25% of FAISM in the year that the loan is acquired. This effectively sets a floor for funds flowing into the trust. FAISM transfers would need to drop by more than 75% before cash flows become insufficient to pay debt service. The assigned ratings also take into account the following structural weakness: - The loan structure does not include a dedicated reserve fund to mitigate against possible delays in the technical transfer of FAISM to pay debt service. However, this weakness is offset by the following consideration: - The lack of an explicit reserve fund is compensated by a grace period feature that tolerates 3 cases of missed debt service payments, only if they are made up before the next payment period without penalties. While this is weaker than a three-month cash funded reserve that can be replenished from excess cash flows and therefore may be available on more than three occasions, this is offset by TESOFE's strong history of timely payment and the short maturity profile of the program (less than three years).We also note that the reserve is intended to provide protection against a delay in payment more than a potential shortfall in available cash flows.
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