Swedish Municipality of Vellinge Long-Term Rating Lowered To 'AA+' On Looser Financial Risk Control; Outlook Stable

  • In our view, Vellinge has shown looser internal financial risk control, a less comprehensive financial risk policy, and less predictable debt and liquidity management.
  • We are therefore lowering our long-term rating on Vellinge to 'AA+' from 'AAA'.
  • The outlook is stable.

On Feb. 15, 2019, S&P Global Ratings lowered its long-term issuer credit 
rating on the Swedish municipality of Vellinge to 'AA+' from 'AAA'. The 
outlook is stable.

At the same time, we affirmed our 'A-1+' short-term issuer credit rating and 
'K-1' Nordic regional scale rating.

The stable outlook reflects our expectation that Vellinge will use its revenue 
flexibility to keep its operating margin above 5% of operating revenues over 
the coming two years, despite an increasing demographic burden. We also expect 
Vellinge will contain its debt burden and maintain its very favorable 
liquidity position. 

Downside scenario
We could lower our rating if we observed an overall deterioration of 
Vellinge's financial position that management is unable to counteract, 
including operating balances structurally below 5% of operating revenues, 
tax-supported debt exceeding 120% of consolidated revenues, and a weakened 
liquidity position. 

Upside scenario
We might consider a positive rating action, including a revision of the 
outlook to positive, if Vellinge displayed a track record of notably 
strengthened financial policies and internal risk controls.

The downgrade reflects our view that Vellinge has shown looser financial 
management than we expected. Specifically, we have observed some shortcomings 
in the internal risk controls. In our view, the policy framework is weaker 
than what we would expect from strong financial management, in 
comprehensiveness, prudency, and predictability. Furthermore, we also consider 
that key person risk exists to some extent, owing to the small size of the 
city's organizational structure, with parts of the financial management 
outsourced to specialized consultants.

That said, Vellinge continues to benefit from a wealthy local economy and 
Sweden's extremely predictable and supportive institutional framework for 
local and regional governments (LRGs), both of which we consider key credit 
strengths. In addition, we anticipate Vellinge's revenue flexibility, stemming 
from a low tax rate, will support its budgetary performance, despite spending 
pressure arising from demographic factors. Moreover, capital expenditures 
(capex) will remain high through 2021, causing tax-supported debt to reach 98% 
of consolidated revenues. Despite our changed view on financial management, we 
consider Vellinge's budget control as strong, owing to a track record of 
budgetary discipline and cost control. Given the political stability, we also 
expect no changes to the city's political priorities. 
Very favorable institutional framework, a wealthy economy, and political 
stability still counterbalance the looser internal risk controls 
We consider Sweden's extremely predictable and supportive institutional 
framework for LRGs a key component for our rating on Vellinge. We consider the 
system as having a high degree of institutional stability. The sector's 
revenue and expenditure management is based on the far-reaching equalization 
system and affords local tax autonomy. 

Due to the extensive equalization system that evens out wealth differences 
among Swedish LRGs, our starting point for the analysis is the three-year 
average national GDP per capita, amounting to $54,000. We consider Vellinge's 
local economy as very rich, although it has no significant labor market within 
its own geographical borders, because of its proximity to cities as 
Copenhagen, Malmö, and Lund in combination with high incomes and very low 
unemployment (4.2% in December 2018, which is clearly lower than regional and 
national levels). 

Despite our changed view on Vellinge's financial management, we consider the 
political situation as stable, where the Moderate party will remain in power 
after the elections last year. Hence, we do not anticipate any major changes 
to the political priorities over the coming term. In our view, Vellinge also 
displays good budgetary control, and has a track record of budgetary 
discipline and conservative revenue and expenditure management.
The liquidity position will likely remain very favorable, although debt is set 
to increase moderately because of high investments 
Owing to a growing population, the demographic burden is set to increase, 
implying lower contributions to the equalization system from Vellinge over the 
coming years. Consequently, we anticipate expenditures will rise and burden 
the operating performance, although we expect operating surpluses will remain 
above 5% of operating revenues through 2021. We expect management will 
counteract pressure on the operating margin by utilizing its strong revenue 
flexibility, stemming from the relatively low tax rate of Swedish krona (SEK) 
18.50 per SEK100. At the same time, we acknowledge that Vellinge's 
operating-expenditure structure is less flexible. Similar to other Swedish 
LRGs, it would be difficult for Vellinge to decrease operating spending 
without reducing important public services.

We expect capex will amount to SEK228 million (or 8.8% of total expenditures) 
on average through 2021, mainly related to core infrastructure, such as 
schools and care homes. Consequently, we calculate Vellinge's deficits after 
capital accounts will average about 3% of total revenues in 2019-2021, which 
is at par with the levels in 2017-2018. In addition, we estimate that the 
company sector, primarily through the self-supporting housing company 
Vellingebostäder AB, will have a net borrowing need of about SEK129 million 
through 2021, which will be lent to it via Vellinge's in-house bank. 

Thus, we expect tax-supported debt will increase moderately to SEK2.7 billion 
by the end of 2021, up from SEK2.3 million in 2018. About half the direct debt 
is lent to the company sector, with Vellingebostäder as the largest borrower. 
In our calculation of tax-supported debt, we also include extended guarantees 
to non-self-supporting subsidiaries and external associations. We forecast 
tax-supported debt will gradually increase throughout the forecast period, but 
remain below 100% of consolidated operating revenues. The in-house bank caters 
to the debt and liquidity needs of municipal group. It funds itself 
exclusively through the capital markets via a SEK2 billion medium-term note 
program and a SEK1 billion commercial paper program.

Vellinge's exposure to contingent liabilities remains very low. The city's 
company sector is relatively small. In addition to the fully owned companies, 
it has a minority stake, together with other municipalities in the western 
part of Skåne, in the water utility company Sydvatten, which faces large 
upcoming investments. Although we expect extended guarantees to Sydvatten to 
increase, we do not consider such guarantees will significantly increase the 
contingency risk for Vellinge. Specifically, we consider the business risk 
within regulated water utility companies as very low, since such companies 
operate at a self-cost principle and can increase the fees for connected users 
to compensate increasing costs. 

We still regard Vellinge's liquidity as exceptional, as we calculate that the 
liquidity sources will cover 113% of the upcoming 12 months' debt service. 
Vellinge relies exclusively on its own sources of liquidity, totaling SEK833 
million and consisting of cash holdings and liquid assets within the pension 
fund, to which we have applied appropriate haircuts according to our criteria. 
The pension assets are available at management's discretion if the need 
arises. We calculate that SEK724 million of Vellinge's debt and interest 
matures within 12 months. We anticipate Vellinge will refinance the maturing 
debt by issuing longer-tenor bonds. We also consider that Vellinge has strong 
access to external liquidity, in line with other Nordic peers. 

Our revised view on management in part is because we have noted volatility in 
the liquidity cover ratio, owing to the city's relatively high debt service. 
However, management has indicated its intention to strengthen the liquidity 
policy, which we think will stabilize the liquidity position. 
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