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(The following statement was released by the rating agency)
Dec 12 -
Summary analysis -- Lodz (City of) -------------------------------- 12-Dec-2012
CREDIT RATING: BBB+/Stable/-- Country: Poland
Primary SIC: Legislative
Credit Rating History:
Local currency Foreign currency
07-Dec-2007 BBB+/-- BBB+/--
28-Aug-2006 BBB/-- BBB/--
The rating on Lodz, which is Poland's third-largest city, reflects our view of the evolving but sound institutional framework for local government in Poland. Lodz also profits from substantial investments in transport infrastructure and a smooth debt repayment schedule.
The rating is constrained by the city's weak liquidity, relatively weak budgetary performance, low budgetary flexibility, and a planned increase in financial debt at the city's companies.
We consider that recent adjustments introduced to the Polish LRGs' institutional framework have encouraged large cities to balance spending and revenues, employ long-term financial planning, limit tax-supported debt, and improve self-funding capacity in the medium term.
As a result, we expect the city to increase its operating surplus from the current very low level, which will allow it to maintain recourse to the capital markets beyond 2014. After 2014, the city's debt service should not exceed its three-year average operating surplus plus privatization receipts. The city has already raised rent fees and public transport ticket prices, and continues to rationalize spending.
In our base-case scenario, we forecast that the city's operating surplus as a percentage of operating revenues will increase to a still-modest 4% on average in 2012-2014 from the low 0.7% recorded in 2010-2011.
Efforts to improve budgetary performance are constrained by Lodz's limited budgetary flexibility, in our view. The central government controls most revenue sources, and operating spending is largely related to indispensable public services. The deficit after capital accounts will be contained by a rising operating surplus and by substantial cofinancing from the EU and state and private investments in transport infrastructure, primarily for an underground railway station.
Nevertheless, in our base-case scenario, the city's high infrastructure needs will cause it to increase capital expenditures (capex) to an annual 20% of expenditures in 2012-2015. In 2010 and 2011, capex was low at an average of 14.7% because of uncertainty over strategy, combined with project delays following a change in management in 2010. As a result, we anticipate that Lodz's average deficit after capital accounts over 2012-2014 will increase to 8.6% of total revenues.
According to our base-case scenario, widening deficits would increase tax-supported debt to a relatively large 98% of consolidated operating revenues in 2014, from 74% in 2010. The city's reliance on long-term borrowings somewhat mitigates the increase in debt service. Owing to the city's limited debt-raising capacity, we expect municipal companies will accelerate borrowing, which also explains the trend for tax-supported debt to rise. We will closely monitor this trend going forward; a typical, and in our view risky, way to overcome borrowing limits in other Central and Eastern European countries has been to switch the debt-raising mandate to the company level.
We assess Lodz's liquidity as "negative." The city maintains a low level of liquid assets. According to our methodology, the city's available cash, combined with an available committed facility, covers only about 50% of the debt service falling due within the next 12 months. We anticipate that due to the relative resilience of the Polish banking sector and its capital market, the city benefits from satisfactory access to bank lending.
In the second half of 2011 and the first half of 2012, the city's average available liquid assets--including cash on accounts, its credit line, and other contracted, but undrawn, credit facilities--accounted for about Polish zloty (PLN) 173 million. The city has increased its committed facility with a local bank to PLN200 million in 2012 from PLN100 million in 2011. According to our methodology, we apply a 50% haircut to Lodz's free cash and committed lines because both are with an unrated bank, Getin Noble Bank S.A.
That said, the city's liquidity coverage ratio may improve. Lodz has been undertaking a massive refinancing of its debt ahead of the 2014 implementation date for new national municipal borrowing regulations. Despite this refinancing, in our base-case scenario, we assume that after 2014 the city's cash and committed facilities (after haircuts) will cover less than 80% of debt service falling due within the next 12 months.
The city is moderately exposed to interest-rate and foreign-exchange-rate risks. For almost all borrowings, interest is linked to variable short-term interest rates, which we view as a credit weakness, and about 11% of debt is denominated in euros.
We consider that the city enjoys only satisfactory access to external liquidity, owing to weaknesses of the domestic banking sector, which are reflected in our BICRA score of '5' (a score of '1' indicates the lowest risk and '10' the highest). For more details, see "BICRA On Poland Maintained At Group '5'," published Nov. 9, 2011, on RatingsDirect on the Global Credit Portal.
The stable outlook reflects our assumption that consolidation measures and the debt refinancing program, as currently envisaged by the city, will help Lodz's management strengthen its self-funding capacity and liquidity while mitigating a gradual, but steady, increase in tax-supported debt.
We could lower the rating within the next 24 months if, as in our downside-case scenario, management fails to curb its operating expenditure growth. This would lead to a higher deficit after capital accounts and heavier indebtedness compared with our base-case scenario. We could also lower the ratings if there were a significant increase in the city's deficit after capital accounts of more than 10% of revenues and the liquidity position remained weak.
Conversely, we could raise the rating with the next 24 months if, as in our upside-case scenario, the city managed to achieve stronger budgetary performance compared with that envisaged in our base-case scenario and further improve its liquidity position. Our upside case assumes that operating surpluses reach about 9% of operating revenues on average in 2012-2014 while the balance after capital accounts stays marginally negative during this period. At the same time, it assumes that average cash and available committed facilities, with the haircut applied, would reach the level of debt service falling due within the next 12 months.
Related Criteria And Research
-- Methodology For Rating International Local And Regional Governments, Sept. 20, 2010
-- Methodology And Assumptions For Analyzing The Liquidity Of Non-U.S. Local And Regional Governments And Related Entities And For Rating Their Commercial Paper Programs, Oct. 15, 2009