The outlook on the rating remains negative, Standard&Poor's said in a statement.
The ratings agency also said in the statement:
"[..] The rating on Zagreb reflects its position as the administrative, financial, and commercial center of the Republic of Croatia (BBB-/Negative/A-3), as well as the city's continuing robust budgetary performance and low direct debt.
These factors are constrained by the city's weak liquidity and limited budgetary flexibility and debt-raising capacity in the context of a consolidating but uneven institutional framework, ongoing tensions between the city's administration and council, as well as high contingent liabilities.
Zagreb plays a dominant economic, financial, and political role in Croatia. With 18% of the country's population, it produces about 31% of GDP. Despite a broadly stagnating economy, we expect the city's GDP per capita to stay slightly below $25,000 over the next three years.
Due to relatively wealthy, service-oriented economy as well as a gradual increase of tariffs on public transport and the water supply, our base-case scenario assumes Zagreb's budgetary performance will remain robust. Its operating surplus as a percentage of operating revenues will account for about a sound 12% in 2012-2015, although it will remain significantly weaker than before the global financial crisis, when it averaged a very high 26% during 2005-2008.
As the central government imposes strict limits on municipal net borrowings, the city cannot afford to have a consistent deficit after capital accounts. In our base-case scenario, we expect Zagreb's budget to remain broadly balanced in 2012-2015.
Consequently, Zagreb outsources its investment program--and concomitant debt accumulation--to Zagrebacki Holding, but provides transfers linked to debt service. While Zagreb's direct debt, including guarantees it services currently, has remained low at about 20% of operating revenues and below 300% of its operating surplus, its tax-supported debt--as a proportion of both the city's and Zagrebacki Holding's operating revenues--increased to 75% at end-2011. We expect the debt accumulation of both to slow, while we forecast the city's operating revenues will grow in line with our base-case scenario. This means the city's tax-supported debt will likely reduce, albeit to a still-sizable 62% of consolidated operating revenues, by end-2014.
The city's financial management is negative for its creditworthiness, in our view. In the years before the global financial crisis, the city rapidly increased its social spending as well as investments funded via its holding company, including in risky real estate projects. Moreover, since the previous municipal election in 2009 the political tensions between the city administration and the city council have intensified. The city administration and council have been slower to adjust its budget spending to reflect shrinking revenues, so payables have accumulated and pressure on Zagrebacki Holding's liquidity position has intensified.
Additional pressure on the city's creditworthiness comes from contingent liabilities associated with Zagrebacki Holding and liabilities to the central government. The holding's financing needs are growing, while the city's ability to cover the entity's additional funding needs immediately and in full has diminished since 2008, in our view. Since 2010, the company has been accumulating losses and covering them with short-term borrowings, and is now exposed to refinancing and market risks.
Besides that, about Croatian kuna (HRK) 337 million or 6% of the city's annual revenues are due to the central government as a result of a contradictory legal framework governing the allocation of shared taxes to local budgets. In 2012, the central government tried to force the city to repay these payables in full, but this was blocked by Croatia's Administrative Court. In our base-case scenario we assume that the city will not be forced to repay these payables all at once.
We view Zagreb's liquidity position as negative, based on its very low cash holdings mitigated by a robust internal cash-generating capacity and satisfactory access to external liquidity.
From November 2011 to October 2012, the city's average cash position was HRK66.2 million (€8.9 million), which accounted for about 17% of its direct debt service falling due within the next 12 months. We estimate the city's direct debt service at about HRK395 million, including annual transfers to Zagrebacki Holding earmarked for debt repayment of about HRK180 million. The city transfers another HRK180 million in line with the rent contracts between the city and the holding, receivables on which are used by the holding as a pledge on its debts. In line with our base-case scenario, we expect Zagreb's cash position to remain low over the next year, but we assume that it will be able to rely on its robust internal cash-generating capacity. Operating surpluses more than doubled the city's debt service in 2013.
During the toughest stage of economic contraction the city also accumulated payables, reaching about 23.7% of the city's annual expenditures by year-end 2011. Nevertheless, in our base-case scenario, we expect payables to return to a sustainable level of about 14% of total spending over the next five years.
Although we view Croatia's banking system as exposed to an ongoing economic contraction, which is reflected by our Banking Industry Country Risk Assessment score of '6' (a score of '1' indicates the lowest risk and '10' the highest), we believe that Zagreb continues to have satisfactory access to external liquidity especially in the context of its very limited borrowing needs.
The negative outlook reflects our view that there is a significant risk that the city's operating surplus will gradually reduce and that liquidity pressures will mount if the city's economy continues to contract, and if it needs to provide additional support to Zagrebacki Holding, or pay its payables to the central government immediately.
We would lower the rating on Zagreb within 24 months if, in line with our downside scenario, the city's liquidity position deteriorated further because of its lower-than-expected cash-generating capacity or if its access to external liquidity deteriorated. Reduced cash-generating capacity could be triggered by the city's operating surplus declining to below 200% of its annual debt service, or 10% of operating revenues.
We would also lower the rating on Zagreb if we were to lower the sovereign rating on Croatia.
We could revise the outlook to stable if the outlook on Croatia is revised to stable and, in line with our base-case scenario (which maintains our 'BBB-' rating), the city continues its strong budgetary performance and improves its liquidity position with cash consistently covering about 50%-60% of annual debt service. This might also allow the city to reduce payables and increase transfers to Zagrebacki Holding, thereby stabilizing the latter's liquidity position."
