The city’s outlook remains stable, the agency said in a statement late on Friday.
The rating agency expects Plovdiv to see "decreasing operating surpluses, relating to expenses for the upcoming European Capital of Culture (ECoC) event in 2019."
S&P also said in the statement:
Our rating on Plovdiv reflects our belief that the city's financial management will use its cash and proceeds from future debt issuance to fund its deficits after capital accounts, which we expect to widen due to the increased expenses for the ECoC event in 2019. The rating on the city remains constrained by the evolving and unbalanced institutional framework and the city's weak economy.
Our assessment of Plovdiv's SACP is 'bbb-'. In accordance with our criteria for rating non-U.S. local and regional governments (LRGs), we generally cap the long-term rating on an LRG at the same level as its respective sovereign. We believe the institutional and financial framework of Bulgarian LRGs limits their ability to meet the conditions specified in our criteria in order to be rated above their related sovereign. In particular, we view their autonomy to be limited by the still-high dependency on central government grants, subjecting local budgets to volatility stemming from intergovernmental relations. The system is also still relatively centralized, with low predictability on the outcome of reforms.
The institutional framework, the economy, and financial management limit the creditworthiness of Plovdiv
The Bulgarian political environment continues to limit the predictability of Plovdiv's finances, given the important role the central government plays in the intergovernmental system. In light of the ongoing decentralization process, we don't rule out the possibility of unexpected changes in the distribution of revenues and government-mandated spending.
Plovdiv's GDP per capita is relatively low compared with international peers, with average GDP over the past three years of about $7,400. On the upside, the structure of the economy has been improving, which is why we expect this figure to grow more or less in line with the national average. With approximately one third of the labor force still working in the manufacturing sector, the city is striving to move away from a low-skilled/low-tech structure to one requiring, and creating, higher-skilled jobs. We also expect tourism to pick up, especially given the city's role as the ECoC in 2019.
The ECoC event has also allowed management to renew its efforts to tackle a backlog of key projects. In general, we assess that the city's financial team is hampered by limited long-term planning and a lack of liquidity management policies, with no established internal guidelines aside from those set in the national legislation.
Budgetary surpluses will remain positive but capital account deficits will widen
We understand that the transfers provided to the city to fund state-delegated tasks--principally maintenance and wages expenses--are calculated on a per-capita basis. Therefore, we have revised our approach to examining all Bulgarian entities and we now include both local and state-delegated revenues and expenditures, roughly doubling Plovdiv's financials. As flows on both sides are similar, this change had no major effect on individual rating factors, but some of our ratios have changed, as detailed below.
We believe that, like in the past, Plovdiv will maintain solid operating surpluses, averaging 5% over 2017-2019. This represents a slight decrease compared with the 2015-2016 results, based on the increasing expenses related to the 2019 ECoC event. Funding for the event should come mostly from the municipal budget, although we expect external parties will also contribute. We expect the central government to contribute to finance capital projects over the next few years. This will enable the city to tackle some of the backlog in its capital program, which is why we believe capital expenses will remain at high levels over our forecasting period. Based on volatile results on the execution of budgets in the past, as well as the fact some of these revenue sources are not yet secured, we believe the actual financial results may be subject to volatility, which we continue to incorporate in our assessment.
The city's total capital plan currently includes renovation of major boulevards, a water treatment facility, and renovation of the city's river bank. While we acknowledge the possibility that the capital program might be scaled down if the city does not secure funding from the EU or other external sources, we believe the city sees most projects as almost mandatory and hence is not likely to postpone them further. The continued pickup in capital expenditures drives our forecast of deficits after capital accounts widening to an average of 2.7% of total revenues over 2017-2019.
Because of the important nature of some of the infrastructure projects, we think that Plovdiv will finance any funding shortfalls by issuing debt. We expect some debt absorption through an already contracted loan with the European Bank for Reconstruction and Development, and more debt will probably be contracted at a later stage through local banks or the Bulgarian Fund for Local Authorities and Governments, as the city has done in the past. Despite this expected debt increase, the inclusion of state-delegated activities in our calculations and the amortizing debt profile support our expectation that the debt burden will now remain well below 30% of operating revenues.
We further expect that despite increasing expenses, the liquidity coverage ratio will remain solid in the next 12 months. Adjusted for our base case of budget execution in the next 12 months, free cash will continue to cover more than 5x the debt falling due over that period. However, we think that management's financial policy remains relatively unpredictable, which constrains our liquidity assessment, especially in light of the fact that the city is capitalizing on the ECoC in 2019 to push through some key projects that have large expected funding needs.
Furthermore, similar to other Bulgarian cities we rate, Plovdiv's access to external liquidity is limited, based on Bulgaria's weak domestic banking sector. This is reflected in our review of the country's banking industry (see "Banking Industry Country Risk Assessment: Bulgaria," published Dec. 30, 2016).
We further note that Plovdiv's flexibility over its budget is now weaker than we had previously forecast. We note that about half of the budget comprises local revenues, which we see as adjustable within certain brackets set by the central government. However, we consider the city's ability to fully utilize this flexibility in practice as limited, due to taxpayers' unwillingness and inability to pay higher taxes. Furthermore, we believe that the headroom to cut expenditures remains limited due to the persistent infrastructure needs and service-related expenses that are necessary for the proper functioning of the city, and preparation for the ECoC event.
Exposure from contingent liabilities arises primarily from payables of health care companies and outstanding litigation cases, but the volume is low compared with consolidated revenues. Although we understand that the city has no plans to financially support its municipal companies, we do not completely disregard the risk of the city stepping in if the municipal companies are in need or under financial distress."
