September 5 (SeeNews) - Standard & Poor's said it has affirmed its long-term issuer credit rating on Bulgaria's capital Sofia at 'BBB-' with a positive outlook.
"We expect Sofia will sustain solid operating performance and high, albeit decreasing, cash levels, and that its nominal debt will increase in 2019-2021 as larger capital projects ramp up in line with the EU cycle," the rating agency said in a statement last week.
Although Sofia's stand-alone creditworthiness is somewhat stronger than that of Bulgaria, the rating agency continues to cap its ratings on Bulgarian local and regional governments (LRGs) at the level of the sovereign credit rating, it added.
S&P also said in the statement:
"On Aug. 30, 2019, S&P Global Ratings affirmed its 'BBB-' long-term issuer credit rating on the City of Sofia, the capital of Bulgaria. The outlook remains positive.
OUTLOOK
The positive outlook on Sofia mirrors that on Bulgaria (BBB-/Positive/A-3). Any rating action we take on the sovereign would likely be followed by a similar action on Sofia, assuming no change in the city's intrinsic credit characteristics.
Downside case
We would revise the outlook on Sofia to stable in the event of a similar action on Bulgaria. We view a downgrade or outlook revision based on Sofia's stand-alone credit quality as unlikely over the coming year. This is because our 'bbb' assessment of Sofia's stand-alone credit profile (SACP) remains one notch higher than the long-term issuer credit rating on the city.
RATIONALE
The long-term rating on Sofia primarily reflects our 'BBB-' long-term sovereign credit rating on Bulgaria. We do not consider that the city meets the conditions under which we would rate an LRG higher than the related sovereign. We consequently cap the long-term rating on Sofia at the level of our long-term rating on Bulgaria. We think that Bulgarian cities, including Sofia, are not able to maintain more resilient credit characteristics than the sovereign in a stress scenario. In particular, we view their creditworthiness as limited by the still-high dependence on the central government's decisions on allocating revenue sources between levels of government, including grants. This subjects local budgets to volatility and the low predictability of central government decisions.
We assess Sofia's SACP at 'bbb'. The SACP is not a rating but a means of assessing the intrinsic creditworthiness of an LRG under the assumption that there is no sovereign rating cap.
The SACP on Sofia is supported by the city's status as the administrative, financial, and commercial center of Bulgaria. While national GDP per capita lags that of European and international peers, Sofia's status supports higher wealth levels than the national average. Thanks to better results in 2018 than those budgeted or forecast, as well as drawdowns on committed loans, the city further increased its cash position. In our opinion, the city will post widening deficits after capital accounts over 2019-2021, owing to a large capital investment program. While this will result in some cash disbursement and accumulation of debt, we expect debt-service-coverage to remain robust and debt to be manageable. We continue to factor into our assessment of Sofia's SACP our view of the still-developing institutional set-up under which Sofia operates.
Despite constraints from the institutional framework and financial management, Sofia's economy outperforms the national average
The institutional framework under which Bulgarian LRGs operate is still evolving. Consequently, the predictability of Sofia's finances is limited, given the important role the central government plays in the intergovernmental system. There might be some unexpected changes in the distribution of revenue and government-mandated spending, due to the ongoing decentralization process.
Furthermore, Bulgaria has a low GDP per capita compared with international peers, forecast at $9,470 in 2019. Nonetheless, we view the city's economic fundamentals as stronger than the national average, thanks to Sofia's role as the financial and administrative center of Bulgaria, and the city's well-diversified service-based economy. Sofia houses the local stock exchange, major banks, and a healthy professional services sector, and it has a clear strategy to promote itself as an investment destination and digital capital. This supports our assessment that the city's socioeconomic profile is stronger than the national average, with higher levels of GDP per capita.
Sofia's economic prospects are likely to remain at least in line with the national average, but we consider financial results are somewhat clouded by weak long-term financial planning, which is less sophisticated than that of international peers. Still, the city tends to overperform its operating budgets and retain high operating surpluses, which helps to maintain high cash buffers. In January 2019, the city council adopted a formalized debt policy, permitting Sofia to use only long-term debt to finance its capital activities, although implementation of capital projects has lagged budgeted targets.
Solid liquidity and strong operating performance will continue to underpin Sofia's credit quality
We project continued solid operating results over 2019-2021, with surpluses averaging about 8.5% of operating revenue, backed by ongoing measures to improve revenue collection, alongside good economic conditions. While the city shows adequate control over expenditure growth, we see increasing pressures on wages in general, stemming from changes to the minimum wage and teachers' salaries, which were decided, and partly funded, by the central government. Furthermore, the city has a large capital program that we assume will keep related expenses high and drive the balance after capital accounts into negative territory. The program includes, for example, the extension of the third municipal metro line, extensive work on the water and sewage network and road infrastructure, and renovation of educational institutions.
While a share of these projects is planned to be funded by EU or national funds, the city will co-finance some investments, potentially causing fluctuations in its overall performance. We expect Sofia will continue to finance a portion of its deficits with new debt issuance, as well as resorting to some of its cash reserves. However, unlike in the past, funding should come only from European institutions, namely the European Investment Bank, reducing risks of unhedged foreign-exchange exposures. We forecast nominal direct debt will rise to about Bulgarian lev (BGN) 870 million (about €445 million) at the end of 2021, which will account for 61% of operating revenue as it increases further. Moreover, we think the city's companies might pose some risk in a stress scenario. Sofia continues to hold ownership stakes in multiple companies, the biggest and most important being the transport companies and the heating company, Toplofikacia-Sofia. These companies do not hold substantial commercial debt, although financial and operating liabilities are high and these might have implications for the city's finances as well.
Sofia has limited access to external liquidity, in our view, due to Bulgaria's weak domestic banking sector. However, we expect the city's liquidity coverage ratio will remain sound over the next 12 months. Adjusted for the expected base case over the next 12 months, free cash reserves and liquid assets will continue to cover debt falling due over the next 12 months by more than 3x."