S&P upgrades Kyiv to 'B-' on domestic bond repayment, outlook stable
S&P Global Ratings raised its long-term issuer credit rating on the Ukrainian capital City of Kyiv to 'B-' from 'CC' on November 24, 2016. The outlook is stable, S&P has said in its press release.
"The rating action follows Kyiv’s decision to cancel the restructuring of its local currency G series bonds maturing on Dec. 6, 2016 and to repay the bonds from the city’s own cash reserves ahead of schedule," S&P said.
The stable outlook reflects our view that Kyiv's absence of commercial debt and sound budgetary performance will counterbalance weaknesses of its financial management and limited access to the capital markets.
"We view Ukraine's institutional framework for local governments as very volatile and underfunded. This continues to limit the city’s budgetary flexibility, which we assess as very weak. Our view of Kyiv's very weak financial management and less than adequate liquidity, as well as high contingent liabilities, also constrains the ratings. We view the city's economy as weak although diversified. The ratings are supported by our assessment of the city's average budgetary performance and low debt burden," S&P said.
The modifiable revenues makeup a relatively low 15% of operating revenues, because most of the taxes are regulated by the central government.
"Moreover, we believe that the city's ability to adjust modifiable revenues is limited. Kyiv's substantial investment requirements and high share of social spending restrict its spending flexibility," the agency said.
"The wealth level is still low compared globally. The city's personal income levels are likely to remain twice as high as the national average, by our estimates. We also think the unemployment rate will continue to be the lowest in Ukraine," S&P said.
S&P assumes that performance is likely to deteriorate in the longer term due to accumulated spending pressures.
"In our 2016-2018 forecast, we expect the operating balance to average 12% of operating revenues, compared with 10% average in 2013-2015. This will be due to high revenue growth fueled by high inflation and the allocation of some new taxes to the city budget (corporate profit tax, excise, and property tax). We expect the central government grants to continue supporting the city," S&P said.
At the same time, spending growth will likely lag behind that of revenues. The relatively high operating balance and modest capital spending will likely translate into surpluses after capital accounts, at about 5.0% of total revenues on average in 2016-2018, compared with the 2.5% average surplus posted in 2013-2015.
Given the expected surpluses after capital accounts, and prepayment of the local currency bond, S&P now believes that Kyiv's tax-supported debt will make up 29% of operating revenues through 2018.
"We also assume that, in line with national legislation, the city will not be allowed to take on commercial debt during the three years after the default on Nov. 6, 2015. As of November 18, 2016, the city's only direct debt was an intergovernmental debt liability of $351.1 million (the two eurobonds that were restructured in November 2015)… Kyiv will need to repay on the maturity date its debt liability to the central government," S&P said.
"We assess Kyiv's contingent liabilities as high since the city's utility companies have accumulated payables to suppliers. We also include $101 million, which is the remaining amount of the eurobonds that the city hasn't yet completed the restructuring on," the agency said.
S&P estimates that Kyiv's average cash position over the past 12 months stood at UAH 4.4 billion (about $150 million). The agency conservatively applies a 50% haircut to the city's cash reserves, as the city keeps them in the Central Treasury and, given the track record of the central government with regard to default, S&P believes that access to these reserves could be interrupted.
"Even using this lower figure, the debt service coverage ratio stays well above 100% over the next 12 months," the agency said.
"We might lower the ratings if we were to lower the sovereign ratings on Ukraine or if we observed an accumulation of commercial debt following a special consent from the central government and as a result of weaker than currently expected budgetary performance. We believe that for the moment there is no upside potential for the ratings on Kyiv," S&P said.