Fitch Ratings - Warsaw - 17 Apr 2020: Fitch Ratings has affirmed the Polish Region of Malopolska's Long-Term Foreign- and Local-Currency Issuer Default Ratings (IDR) at 'A-'. Fitch has also affirmed the region's National Long-Term Rating at 'AAA(pol)'. The Outlooks are Stable. The rating affirmation reflects our expectations that Malopolska has rating headroom to withstand economic disruption from the coronavirus pandemic. While the region's debt payback ratio will weaken due to contraction in the operating balance, it should remain compatible with the current ratings. The region's standalone credit profile (SCP) is 'a'.
KEY RATING DRIVERS
Risk Profile: 'Midrange'
Malopolska's risk profile is assessed at 'Midrange', in line with other Fitch-rated Polish regions'. Its risk profile (or debt tolerance) reflects moderate risk of cash flow shrinking to levels that are insufficient for debt service or of annual debt service increasing above expectation. The risk profile combines a 'Stronger' expenditure adjustability and 'Midrange' assessment of revenue robustness and adjustability; expenditure sustainability; and liabilities and liquidity framework.
Revenue Robustness: 'Midrange'
Fitch has revised upwards its assessment of revenue robustness to 'Midrange' from 'Weaker' for all rated Polish regions to reflect stable revenue from the Polish state (A-/Stable) and parts of tax revenue being based on moderately cyclical economic activities, such as personal income tax (PIT). Malopolska's total revenue is dominated by corporate income tax (CIT), which averaged 32% of total revenue in 2015-2019, followed by stable revenue sources such as current transfers from the state and the EU (28%), PIT (10%), and other revenue sources (4%). Capital grants from the EU and the state (24% of total revenue) generally follow capex trends.
Fitch expects the national economic slowdown triggered by the pandemic (with projected GDP decline of 0.6% in 2020) to affect the region's CIT revenue, which is highly sensitive to economic fluctuations. Our rating case expects the region's CIT revenue to decline 30% in 2020, before rebounding from 2022.
Revenue Adjustability: 'Midrange'
We assess Malopolska's ability to generate additional revenue in response to possible economic downturns as 'Midrange' in view of the national equalisation scheme for Polish regions. Malopolska has benefited from equalisation transfers in recent years, but could qualify for higher amounts in case of falling tax revenue. Malopolska has limited tax-revenue-raising flexibility, as income tax rates are set by the state.
Expenditure Sustainability: 'Midrange'
Fitch has revised downwards its assessment of expenditure sustainability to 'Midrange' from 'Stronger' for all rated Polish regions to reflect a historical pattern of total expenditure growth tracking total revenue growth and some responsibilities being based on moderately counter-cyclical responsibilities. Malopolska has mostly non-cyclical responsibilities, including public transport (21% of total expenditure in 2018), administration (11%), culture (11%) and education (7%) as well as capex (35% of total).
Expenditure Adjustability: 'Stronger'
Malopolska has a proven record of expenditure adjustability. It benefits from high spending flexibility, as reflected in a moderate share of fixed operating costs in total expenditure (staff costs: below 20% in 2015-2019) and a high share of capex (about 39% in 2015-2019). We expect that Malopolska, as with other regions, can mitigate the sharp fall in revenue following the pandemic by cutting its discretionary operating expenditure on road maintenance and repairs, the promotion of the region's heritage and economic strengths, and cultural events, among others. Further, Malopolska may postpone some of its investments or partially scale them back as they are predominantly small and medium-sized infrastructure projects. Consequently, we expect the region to tap its expenditure flexibility in the event of a sharp decline in revenue.
Liabilities and Liquidity Robustness: 'Midrange'
Malopolska's debt has a smooth amortisation profile with PLN45 million of repayments annually. The region is exposed to interest-rate and foreign-exchange risks, as its whole loan portfolio is floating-rates and 50% is loans in euros from the Council of Europe Development Bank and the European Investment Bank. Those risks cannot be hedged due to legal restrictions on Polish local and regional governments (LRGs), but are mitigated by prudent budget management. Moreover, interest-rate risk is limited for 2020 following cuts to the reference rate to 0.5% in April 2020 from 1.5% at the beginning of the year.
Indirect risk stemming from the region's shareholdings (including healthcare units) is low and Fitch expects the region's financial support for healthcare units to also remain low in the medium term, at no more than 2% of total expenditure.
Liabilities and Liquidity Flexibility: 'Midrange'
Malopolska had a long record of high liquidity until it started to be absorbed by investments since 2018. Since July 2018 the region has a PLN50 million committed liquidity credit line with Powszechna Kasa Oszczednosci Bank Polski S.A. Our rating case projections foresee a liquidity coverage ratio on average of 2.5x in 2020-2024, compared with 6.1x in 2015-2019.
Debt sustainability: 'aa' category
Fitch has revised its rating-case assumptions to factor in the expected economic downturn triggered by the pandemic. We expect the region's debt to double to about PLN730 million at end-2024 in view of a capex plan of PLN2.1 billion for 2020-2024. The debt stock will rise to 69% of operating revenue (2019: 24%), but still compatible with a 'aa' debt sustainability score. With a weaker operating balance projected under our revised rating case and rising debt, debt payback will rise to 6.2x in 2024 (1.1x in 2019), but remain compatible with 'aa' debt sustainability. The synthetic debt service coverage ratio (DSCR) is likely to worsen to 1.8x (from 13x in 2019), corresponding to 'a' debt sustainability. However, as two out of the three ratios are firmly placed within 'aa', Fitch has maintained the overall debt sustainability assessment at 'aa'.
While Polish LRGs' most recently available data may not have indicated performance impairment, material changes in revenue and cost profiles are occurring across the sector and likely to worsen in the coming weeks and months as economic activity suffers and government restrictions are maintained or broadened. Fitch's ratings are forward-looking in nature, and we will monitor developments in the sector for their severity and duration, and incorporate revised base- and rating-case qualitative and quantitative inputs based on performance expectations and assessment of key risks.
Malopolska is the fifth-largest contributor to national GDP among 16 Polish regions, as it added 8.1% to national GDP in 2018. However, due to its large population of 3.4 million, GDP per capita was at 92% of the national average in 2018 and 65% of the EU27 average. The regional economy is well-diversified and service-oriented, but with large economic disparities among its sub-regions. The unemployment rate in the region was 4.1% at end-2019 (national 5.2%).
The region's 'a' SCP reflects a combination of a 'Midrange' risk profile and a 'aa' debt sustainability. The SCP also factors in a peer comparison. The region's IDRs are not affected by any asymmetric risk or extraordinary support from the Polish state. Malopolska's IDRs are capped by Poland's.
Qualitative assumptions and assessments:
Risk Profile: Midrange
Revenue Robustness: Midrange
Revenue Adjustability: Midrange
Expenditure Sustainability: Midrange
Expenditure Adjustability: Stronger
Liabilities and Liquidity Robustness: Midrange
Liabilities and Liquidity Flexibility: Midrange
Debt sustainability: 'aa' category
Asymmetric Risk: n/a
Sovereign Cap or Floor: Yes
Quantitative assumptions - issuer-specific
Fitch's rating case is a "through-the-cycle" scenario, which incorporates a combination of revenue, cost and financial risk stresses. It is based on 2015-2019 figures and 2020-2024 projected ratios. The key assumptions for the scenario include:
- Operating revenue to decline 3.4% yoy on average in 2020-2024, including a 30% fall in CIT revenue in 2020, with a mild recovery on average of 5.5% annually from 2022;
- Aggregate decline of operating expenditure of around 3% in 2020-2021 and flat growth on average in 2022-2024;
- Net capital deficit on average of PLN154 million annually in 2020-2024; and
- Cost of debt rising to 4% in 2024 from 1.2% in 2019 and 10-year maturity for new debt.