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ICRA Lanka revises Construction Guarantee Fund rating

19 Jan 2021

ICRA Lanka Ltd. has revised the issuer rating assigned to Construction Guarantee Fund (CGF) to (SL) A with a Stable outlook, from (SL) A- with a Stable outlook. Nevertheless, ICRA noted that the Stable outlook reflects ICRA’s expectations that CGF will continue to benefit from its sector specialty, as well as the new partnership with the Road Development Authority (RDA). The rating revision primarily factors in the Government of Sri Lanka’s recognition of the fund as a longstanding key player in Sri Lanka’s construction industry. This was further witnessed by the fund’s recent partnership with the RDA, providing its services/guarantees on behalf of all the construction contractors under the “Saubhagya Dakma Programme”, which targets the construction of 100,000 km of rural road networks around the country. This programme has not only helped CGF increase its operational scope during 2020, but also to envisage its due recognition as a fund manager in the local construction industry with two decades of experience. Moreover, ICRA Lanka is confident in the ownership and the sovereign support to the fund.  ICRA Lanka also notes the fund’s unique operational model as a non-profit service organisation in Sri Lanka, its stringent underwriting standards, and its self-sustaining operational structure that requires minimal support from the Government.  This, coupled with the entity’s governance system that is administered through its Board of Trustees, representing key public and private sector officials, has enabled the fund to operate as an autonomous body without interference from the Government. ICRA Lanka notes the fund’s comfortable liquidity profile and the healthy capitalisation metrics, commensurate with its business profile.  The investments of the fund mainly consist of government securities and risk-free assets. The rating strengths are partly offset by the continued downturn in the domestic construction sector over the past three years, amidst the exceptional events that have taken place during this period. Historically, the fund’s bond exposure has been highly skewed towards state-funded construction contracts. Given the Government’s fiscal constraints, ICRA Lanka views this exposure on a negative note, as delayed payments from the government sector have affected the construction industry in Sri Lanka, especially over the past two years. The Construction Guarantee Fund was originally set up by a Budget proposal by Parliament in 1999 and the Government had disbursed a capital grant of Rs. 55 million in four installments. The Secretary to the Treasury was tasked as the settlor of the CGF, and delegated the fund’s total management to a Board of Trustees, who are also appointed from reputed government bodies and private sector entities.  Moreover, the Board of Trustees acknowledged in the Trust Deed have provided the overall maximum liability that the fund could undertake (against its capital base), and further delegated responsibilities to the senior management. This structure has helped the fund operate as a self-sustained-Special Purpose Vehicle (SPV), without direct influence from the Government, and also to operate without highly leveraging the fund’s capital base over the past two decades, although the total gross liability of the Fund has increased significantly during the first eight months of 2020.  The fund is guided by a management team with several decades of experience in the construction industry. The entity also has a strong Board of Trustees, consisting of reputed public and private sector industry representatives. Over the past years, the management has been able to maintain good relationships with all stakeholders in the industry, including ministries, employers, and contractors, which has ensured the fund’s operation even when the construction industry was experiencing a slowdown.  Moreover, being a Government entity, the fund is in a better position to negotiate any contract-disputes on behalf of its clients with government employers. This has also helped the fund resolve contract disputes more amicably and reduce the level of claims/invocations over the past. Although the fund increased its scope in 2020 under the 100,000 km rural road development programme, the trade payments for the construction contractors under this programme are channelled through the CGF, which also helped the fund manage its project portfolio based on the progress of the construction projects.    The CGF provides various guarantees/bonds without retaining any collateral, insurance money, or property for the guarantees offered. However, commercial banks/insurance companies also offer such facilities by retaining valuable properties as security, in addition to higher service charges to mitigate their risks. Furthermore, large scale construction contractors generally prefer such facilities from commercial banks, as the fund’s continuous engagement with the ongoing projects are viewed negatively by large scale contractors.  Therefore, the Fund generally caters to small- and medium-scale construction contractors and encourages them to uplift their level to a higher capacity/contactor grade in an open manner. Moreover, most construction contractors, who have uplifted their grade with the Construction Industry Development Authority (CIDA), then shift to commercial banks from the CGF.  Generally, this would take a relatively longer time, and these types of contractors are generally replaced with emerging new small- to medium-scale contractors. Currently, commercial banks are very selective in funding of construction projects due to increased risks of the industry. Therefore, the demand for various guarantees offered by the CGF has increased recently, notwithstanding the continued slowdown of the industry in Sri Lanka.  Moreover, under the 100,000 km rural road development programme, the fund provides its services to all the construction contractors of this programme regardless of their contractor grades.  


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