SOFIA (Bulgaria), September 4 (SeeNews) – Standard & Poor's said it has affirmed its long-term issuer credit rating on Bulgaria's capital Sofia at BB+ with a positive outlook.
"We expect the city of Sofia will continue exhibiting solid operating performance and high cash levels, but that nominal debt will increase slightly in 2018-2019 as larger capital projects accelerate," the rating agency said in a statement late on Friday.
The positive outlook continues to reflect the outlook on Bulgaria, S&P added.
S&P also said in the statement:
"RATIONALE
Our rating on Sofia reflects our expectation that, over 2018-2019, the city will continue posting robust operating balances averaging 9% and its liquidity will remain exceptional, even with continued large capital expenditures (capex). The high capital expenses will result in deficits, which we expect will be contained and funded by new debt over our forecast period. The main constraints to the rating continue to be the evolving and unbalanced institutional framework under which Sofia operates and the city's financial management, as shown by limited long-term budgetary planning.
Although we assess Sofia's SACP at 'bbb', we generally cap the long-term rating on local and regional governments (LRG) at the long-term rating on the respective sovereign. We believe the institutional and financial framework in Bulgaria limits LRGs' ability to meet our conditions to be rated above the sovereign. In particular, we consider the LRGs' autonomy to be limited by their still-high dependence on central government grants, which subject their budgets to volatility stemming from intergovernmental relations, as well as by the still relatively centralized system, with low predictability of the outcome of reforms.
Institutional framework and financial management constrain Sofia's creditworthiness, but its economy remains stronger than the national average
The Bulgarian political environment continues to limit the predictability of Sofia's finances, due to the important role the central government plays in the intergovernmental system. Given the ongoing decentralization process, we cannot rule out the possibility of unexpected changes in the distribution of revenues and government-mandated spending. Therefore, the institutional framework continues to restrict our assessment of the creditworthiness of all Bulgarian municipalities, including Sofia.
Another constraint is management's expertise. We view the city's long-term planning and budgeting as limited and its control over municipal companies as weak. Yet we recognize that Sofia's management maintains a conservative approach by taking on debt only for key infrastructure projects and by keeping high levels of cash. Adequate overall budget execution is also reflected in the city's financials.
Furthermore, we view Sofia's economic profile as constrained by Bulgaria's particularly low GDP per capita (US$7,300 in 2016) compared with that of international peers. Although we see a structural improvement in the country's economic fundamentals as unlikely in the short-to-medium term, we view wealth levels in Sofia as higher than the national average, which reflects the city's well-diversified economy. Economic activity is concentrated in the services sector (85% of Sofia'sGDP), and the city has a clear strategy based on promoting itself as an investment destination and a digital capital.
A solid liquidity position and strong operating performance will help limit new debt, despite an ambitious capital program
We understand that state transfers to the city for funding state-delegated tasks, principally to pay for maintenance and wages, are calculated on a per-capita basis. Therefore, we have now revised our approach in examining all Bulgarian entities and include both local and state-delegated revenues and expenditures, roughly doubling Sofia's budget. Because operating revenue and expenditure flows were similar, this change had no major effect on our assessment, but some of our ratios have changed.
More specifically, we foresee continued solid operating results over 2017-2019, with surpluses now averaging 8.8% of operating revenues, backed by ongoing measures to improve collections, alongside better economic conditions and adequate control over expenses. Nonetheless, the city has a large capital program, which we expect will keep related expenses high and drive the balance after capital accounts into negative territory. The program includes, for example, the third phase of the municipal metro extension, 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 mostly funded by EU or national funds, some will be co-financed by the city, which for Sofia could result in volatile overall performance. We expect that, as it has done over the past few years, Sofia will continue to finance its deficits with new debt issuances, with the debtholders most likely being European entities. We forecast nominal direct debt will rise to about Bulgarian lev (BGN) 728 million (about €370 million) in 2019 from BGN643 million in 2016, although it will still account for 68% of operating revenues as these increase further.
Under our base case, Sofia's capex would average about 15% of total expenditures in 2017-2019. Sofia enjoys high flexibility in adjusting its local revenues within certain brackets set by the central government. Following our change in analytical approach, these revenue sources now amount to about 60% of operating revenues, which we consider high. Nevertheless, we continue to see the city's willingness to use this flexibility as limited.
We expect the city's liquidity coverage ratio will remain sound over the next 12 months. Adjusted for the expected deficit, free cash reserves and liquid assets will continue to cover the debt falling due over the next 12 months by almost 3x. Sofia also generates strong internal cash flow, as reflected in high operating surpluses that cover more than 200% of annual debt service. However, as for other Bulgarian municipalities, we view Sofia's access to external liquidity as limited, due to weaknesses in the domestic banking system (see "Banking Industry Country Risk Assessment: Bulgaria," published Dec. 30, 2016, on RatingsDirect).
We continue to assess Sofia's contingent liabilities as higher than its peers'. Sofia has ownership stakes in multiple companies, but the transport companies and the heating company, Toplofikacia-Sofia, are the most important ones, accounting for about 80% of the municipal companies' liabilities. Another contingent liability is Sofia's ownership of Municipal Bank A.D., which may incur additional costs under a stress scenario. Overall, we believe that, if these risks materialize, the associated liabilities for the city would be equivalent to 15%-30% of the city's consolidated revenues."