(The following statement was released by the rating agency)
Jan 25 - Fitch Ratings has affirmed the City of Milan’s Long-term foreign and local currency ratings at ‘A-’ and Short-term foreign currency rating at ‘F2’. The Outlooks on the Long-term ratings are Negative, mirroring those on Italy’s sovereign rating. The rating action affects about EUR4.3bn of financial debt outstanding , including EUR1.7bn bonds, and future direct borrowing.
The affirmation reflects Fitch’s expectations of debt stabilisation over the medium term supported by a balanced budget thanks to revenue resiliency despite ongoing economic recession, and investment sized to asset sales and capital subsidies.
Fitch expects Milan’s operating balance to hover around EUR250m in 2012-2015, or about 8% of revenues, as increases of personal income tax (PIT), property tax and transport fares offset cuts in subsidies while replacing one-time revenue such as capital gains on asset sales. The debt service coverage which in Fitch’s central scenario weakens to 0.9x of the operating balance in 2013, could re-strengthen to 1x by 2015 when the economic recovery could have a positive bearing on the budget via more cyclically sensitive revenues, such as PIT and waste tax.
Recession in 2012/13 are not expected by Fitch to have an impact on the budget as the bulk of taxes are based on the cadastral rather than the market value of properties. Redundancies in the banking and commerce sectors, subsequent to corporate restructuring, will prolong the employment base’s weakness into the medium term. The economic slackness may limit revenues’ compound annual growth rate to 3% over 2013-2015, exposing the budget to cost pressures once the freeze on wages ends in 2014 and interest rates start eventually to rise.
As tax and fee hikes will not provide free resources, investments will be reliant on asset sales. Fitch expects budgetary investments to fall by one-third to EUR0.5bn per annum over 2013-2015, compared with 2010-12, with the bulk of it remaining centred on transportation. In the run up to the World Expo 2015, part of the debt-funded capex is being carried out by municipal companies, to tackle constraints on the municipal spending and borrowing.
Spending pressures are unlikely to divert Milan from the balanced budget it roughly achieved in 2011-2012. Under Fitch’s baseline scenario, borrowing will cover 25% of the EUR2bn investments over 2012-2015, while matching the principal repayment yoy. Debt will therefore stabilise at about EUR4.2bn, yet its sustainability is weakening, as the pay-back edges towards 40 years of the current balance from 25 in 2010-2012. Milan is somewhat exposed to rate rises as 50% of its debt stock carries floating rates after the closure of interest rate swap transactions on the EUR1.7bn bond.
The city has never reneged on its swap commitments entered into in 2005 on a notional amount of EUR1.7bn and at the beginning of 2012 agreed with the bank counterparties a partial closure of the transactions. Although in December 2012 the Milan tribunal ruled that the city was charged improper costs, and therefore defrauded of about EUR100m, the case is unlikely to come to a definitive conclusion in the short term as banks are likely to appeal the ruling. Pending a final decision the EUR100m has not been seized.
Fitch expects Milan’s traditionally strong cash flow generation to be safeguarded by offsetting, with adequate provisions, the increase of difficult-to-collect taxes and fees which, from 2012, will be recorded when levied rather than when cashed. The free fund balance is likely to hover around EUR50m, or 2% of the budget, with cash eventually halving to EUR0.5bn over the medium term from about EUR1bn in 2011/2012 amid persisting slack in the economy which may force taxpayers to postpone tax settlements while cash reserves are absorbed by progress in the execution of projects.
Milan’s ratings, which remain vulnerable to a sovereign downgrade, may be downgraded if the operating margin weakens towards 5%. Conversely, and assuming the Outlook on the sovereign rating is revised to Stable, Milan’s Outlook could also be revised to Stable if the city continues to deliver balanced budgets, thereby stabilising debt at EUR4bn, while limiting the growth of debt liabilities of its tax-supported companies and the depletion of its free reserves
The analysis assumes a modest rate of growth of both revenues and spending, driven by the sluggish economy and austerity measures, and relatively stable market rates as 50% of Milan’s debt carries floating rates. Tighter borrowing limits from 2013 and the requirement of a balanced budget from 2014 implies debt stability.