Fitch Ratings has assigned expected ratings of 'AA+(EXP)' to Rio Smart Lighting S.ar.l. (Rio Smart) forthcoming proposed senior secured notes issuance of BRL925 million.
The Rating Outlook is Stable.
The rating reflects a transaction supported by a USD267 million guaranty provided by U.S. International Development Finance Corporation (DFC, not publicly rated) that will be in place throughout the entire life of the notes. The credit quality of the DFC is viewed as directly linked to that of the United States (AAA/F1+/Negative). The unconditional and irrevocable guaranty covers a fixed amount that represents a buffer above the notes' issuance amount.
As the guaranty is denoted in USD and the notes are denominated in Brazilian Reais (BRL) the guaranty buffer may reduce in case of appreciation of the BRL. Even though the guaranty may not cover the full payment of principal under all circumstances (full wrap), it prevents default in most macroeconomic scenarios that are consistent with the assigned rating, denoting expectations of very low default risk. The notes will be senior secured, fully amortizing and fixed rate.
KEY RATING DRIVERS
Payment Source from End-User [Revenue Risk: Midrange]
The public-private partnership (PPP) agreement with the Municipality of Rio de Janeiro (RJ) establishes that the remuneration of the project is a percentage of the COSIP, a tax created in 2009 to fund the public lighting system embedded in the electricity bill of all end-user consumers in the city, upon completion of certain milestones, with limited deductions due to performance. The project bears some volume risk as COSIP collections can fluctuate due to electricity consumption seasonality, and delinquencies of electricity bills, for example. COSIP is collected by Light S.A., which is legally required to transfer the gross amount collected to an escrow account managed by Caixa Economica Federal, that ultimately transfers the payments to the concessionaire. The tariff for COSIP is already fixed, and is annually readjusted by the Municipality.
Low Operational Risk [Operational Risk: Midrange]
Operational risk is fairly mitigated by the simple nature of works to operate and maintain the public lighting system of the city of RJ. The project will be operated and maintained by several experienced operators in the area, which, according to Arcadis (Independent Engineer), is a common practice in the sector to allow the parallel advancement of different workstreams and timely replacement of operators, if needed. According to the IE report, the scope of O&M services comprises performance, execution, conclusion of services, preventive and corrective maintenance and efficiency services of the lighting points in urban streets, places and communities, but it excludes any supply of materials. Costs are expected to be predictable and stable from 2023 onwards, after all the main works are performed in the first two years of the concession. The transaction will include a three-month O&M reserve account.
Adequate Plan for the Infrastructure Development & Renewal [Infra & Renewal: Midrange]
Main works for the project are expected to occur in the first two years of the concession, and are heavily concentrated on the exchange of the LED bulbs of RJ street lighting. Main maintenance works are embedded in the O&M contracts. The main risk for the project is technology obsolescence, as the PPP contract requires the project to upgrade certain IT equipment and systems of the Control Center at their own cost. The works in the Control Center are expected to be made in 2026 and 2031, with the project's cashflow.
DFC Guarantee Enhances Debt Structure [Debt Structure: Stronger]
The debt structure will benefit from a guaranty provided by DFC, that covers principal and interest to prevent the notes' default. The guaranty will be capped at USD267 million for the principal payments during the notes' tenor. In case the guarantee is triggered, DFC has the option, but not the obligation, to accelerate the notes upon several conditions. If not accelerated, DFC will continue to make the debt service payments directly to the trustee. The debt structure includes a six-month debt service reserve account, as well as strong covenants such as dividend distribution triggers at 1.20x.
The maximum guaranteed amount will be fixed until March of 2026 and after that, it will be reduced by an amount in U.S. dollars equal to the principal amount paid, at the exchange rate of the transaction's closing. The guaranty is expected to fully cover the principal payments in different scenarios of BRL appreciation. Considering the currency mismatch between the guaranty cap (USD) and the debt (BRL), the exchange rate (BRL/USD) breakeven is 3.46 in November 2022, 3.09 in May 2025, and decreases over time, which considering the current exchange rate and future expectations through the 11-year tenor of the debt imply a very low risk of default.
Fitch ran base and rating cases to evaluate the credit quality of the underlying project. Under the rating case, the minimum and average DSCRs are 1.07x and 1.10x (2023-2031), respectively. Management expects to perform some technology upgrades for the data processing and IT equipment and refurbishment and upgrade of systems of the Control Center in 2026 and 2031. Those investments are not contractually defined, and depending on the rate of technological advance, could ultimately affect the debt service coverage ratios (DSCRs) once the project is exposed to this risk. The revenue structure, which depends on fluctuating COSIP collections, potential technology investments and tight metrics in the rating case, lead the underlying credit quality of the project, without the guarantee, to be consistent with a 'B' category rating.
Rio Smart's debt structure is comparable with Pirapora Solar Holding S.A's first issuance of debentures (Pirapora, rated at A+ and AAA(bra) both with Stable Outlooks), due to the guarantee provided by Inter-American Development Bank (IDB; Long-Term Issuer Default Rating [IDR] AAA/Stable) and Inter-American Investment Corporation (IDB Invest; Long-Term IDR AAA/Negative), which is limited to a maximum amount of BRL315.3 million during the debentures' tenor. Both guarantees are provided by counterparties with a very strong credit quality, but there are differences in the exposure to macroeconomic conditions or operational stresses of both transactions.
Smart Luz presents stronger protection to investors, as the notes are not indexed to inflation but are fixed rate. Also, scenarios under which Rio Smart's guarantee would not fully cover the outstanding notes are considered more remote than Pirapora's.
Factors that could, individually or collectively, lead to negative rating action/downgrade:
Any change in Fitch's view of the credit quality of the DFC counterparty could result in the notes being downgraded.
Factors that could, individually or collectively, lead to positive rating action/upgrade:
Unlikely given the transaction's debt structure.
Best/Worst Case Rating Scenario
International scale credit ratings of Sovereigns, Public Finance and Infrastructure issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of three notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from 'AAA' to 'D'. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit https://www.fitchratings.com/site/re/10111579.
Rated notes will be issued by an offshore SPV, and will be BRL denominated. The notes will include a guarantee from DFC at an expected maximum amount of USD267 million. Sources will be used to fund the first phase of the PPP Public Lighting capex.
The rating also considers the project's current phase of investments, where revenue increases are linked to the achievement of certain milestones related to relatively simple works - the modernization and efficiency of street lighting points and pole replacements. The revenues are dependent on the Contribuicao para Custeio do Servico de Iluminacao Publica (COSIP) collections that are done by Light S.A. (Local Currency Long-Term IDR of BB-/Stable) and are passed through to an account controlled by Caixa Economica Federal (Local Currency Long-Term IDR of BB-/Negative) that makes the payments to the concessionaire. Since the COSIP payments are funded by the end-users' electricity bills in the city of RJ, Fitch considers that the counterparty payment risk ultimately lies with that broad group of end users.
Operations and maintenance are considered to be low complexity, with sufficient predictability and some exposure to lifecycle investments to upgrade the technology.
Fitch's cases were run for the purpose of evaluating the underlying credit risk of the asset. For the assumptions, Fitch used the macroeconomic assumptions detailed in Fitch's 'Global Economic Outlook' report, published in September 2021, operating costs and investments recommended by Arcadis, and COSIP collections estimated by Mercados Energeticos. The performance factor was assumed to be between 93% and 95%, resulting in a 2% discount in revenues in the rating case. The base case assumed a performance score between 95% and 100%, which resulted in no deductions in the revenues.
The minimum and average DSCRs for the base case are 1.24x and 1.26x, respectively. In Fitch's rating case, the minimum and average DSCRs are 1.07x and 1.10x, respectively.
REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING
The principal sources of information used in the analysis are described in the Applicable Criteria.
PUBLIC RATINGS WITH CREDIT LINKAGE TO OTHER RATINGS
The ratings reflect the guaranty provided by U.S. International Development Finance Corporation.
Unless otherwise disclosed in this section, the highest level of ESG credit relevance is a score of '3'. This means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity. For more information on Fitch's ESG Relevance Scores, visit www.fitchratings.com/esg.RATING ACTIONSENTITY/DEBT RATING Rio Smart Lighting S.ar.l.
Rio Smart Lighting S.ar.l./Notes/1 LT
LT AA+ New Rating
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