City of Stockholm Outlook Revised To Negative On Risk Of Uncontained Debt Burden; Ratings Affirmed


  • To meet the demands of its growing population, the City of Stockholm will continue to make high investments in the company sector over the coming years, leading to substantial borrowing needs.
  • Despite the new political leadership's ambition to contain its debt burden, we forecast that the city's debt will increase notably through 2021.
  • We are therefore revising our outlook on Stockholm to negative from stable, while affirming our 'AAA/A-1+' issuer credit ratings and 'K-1' Nordic regional scale rating.
  • The negative outlook reflects the increased risk that Stockholm's massive ongoing investment program may materially elevate the debt burden of its municipal companies.

Rating Action

On May 17, 2019, S&P Global Ratings revised the outlook on the Swedish capital city of Stockholm to negative from stable.
At the same time, we affirmed our 'AAA/A-1+' long- and short-term issuer credit ratings and 'K-1' Nordic regional scale rating on the city.

Outlook

The negative outlook reflects the rising risk that the city's new leadership might fail to contain the city's rising debt, which is the result of substantial investments related to infrastructure, housing, and education. High borrowing needs could dent the city's ability to withstand a 'AAA' stress scenario.
Downside scenario
We could lower our ratings on Stockholm over the coming two years if management either abandons, or fails to pursue its strategy to contain increasing debt, for instance, by selling assets, resulting in a debt burden structurally above 120% of operating revenue.
Upside scenario
We could revise the outlook to stable if the city remains committed to fiscal dicipline and efficiently executes its plan to contain increasing debt, broadly stabilizing the city's debt below 120% of operating revenue.

Rationale

We revised the outlook to negative given our view of an increased risk that Stockholm will not be able to contain its increasing debt, stemming from high company-sector investments. If the city is unable to utilize its revenue flexibility, despite its ambition to do so, Stockholm's debt position may deteriorate and make the city more vulnerable in our 'AAA' stress scenario.
That said, in our base scenario, we believe that Stockholm will maintain its strong operating performance and budgetary discipline, supported by a very favorable local economy and Sweden's institutional framework for local and regional governments (LRGs). In our base case, we also assume that the city would use its flexibility, stemming from a relatively low tax rate and large pool of sellable assets, to contain the debt burden, and any pressure on operating expenditure. Furthermore, we expect the city's treasury will remain committed to prudent financial policies to minimize financial risks.
Financial sustainability is a key focus of the city's new leadership
We consider the Swedish institutional framework for LRGs a key factor in our ratings on Stockholm. In our view, the system is extremely predictable and supportive, since it displays a high degree of stability. Revenue and expenditure management is based on a far-reaching equalization system and autonomy in setting local taxes. Owing to the equalization system, which evens out wealth among the municipalities, we base our analysis on the Swedish national GDP per capita, amounting to $53,300.
In our view, Stockholm benefits from a very strong and diversified local economy. The city headquarters many of the largest companies in Sweden and is the financial center of the Nordics. Consequently, unemployment is low, amounting to 5.7% as of March 2019, which is below the national average. In addition, income levels in the city are among the highest in Sweden, making Stockholm one of only few net contributors to the municipal equalization system.
A right-center-green majority coalition now governs the city following 2018 elections, and we understand that there is consensus regarding the city's long-term expansion plans, and we therefore do not expect any major strategy changes during the term period. The new leadership is emphasizing the importance of containing the increasing debt, and we expect the city will concretize and implement its strategy in the coming years.
Divestments may contain the increasing debt
We expect Stockholm's operating balances will remain stable, averaging 5.2% of operating revenue annually in 2019-2021, which is on par with 2018. We have revised down our base-case projections since our last review, given that the city decided to lower the tax rate to 17.74% from 17.90%, supported by its healthy economy and solid budgetary performance, in combination with sector-wide demographic pressure on operating spending. We anticipate Stockholm will remain committed to budgetary discipline and counteract pressure on its financial position by making use of its ample revenue flexibility, stemming from one of Sweden's lowest tax rates and large pool of sellable assets, if needed. That said, we consider the expenditure side as rigid, given that many of its responsibilities are compulsory and not easily reduced.
Owing to the growing population, we anticipate capital expenditure (capex) will remain high throughout the forecast period. The company sector carries out the vast majority of the investments related to schools (via SISAB), the construction of apartments (via the housing companies), and the water company.
In addition, we expect the city's own investments will remain high, averaging Swedish krona (SEK)6.4 billion (about €611 million) per year in 2019-2021. We anticipate the city will be able to self-finance its investments and generate a surplus after capital accounts, averaging about 2.4% of total revenue annually in 2019-2021, compared with a deficit of 1.7% in 2018. A historically high completion rate of capex drove the deficit in 2018. Furthermore, we continue to consider the city's surplus after capital accounts distorted, because we consider some of the company-sector investments as core municipal activities.
Consequently, we estimate that the city's direct debt will reach 114% of operating revenue in 2021, up from 82% in 2018. To meet the company sector's funding needs, we estimate the city will continue to raise debt and on-lend substantial amounts in 2019-2021. That said, we consider it a mitigant that the majority of the borrowings are made by housing companies and the water company, which we consider self-supported due to their low business risk and sound financial profiles.
We estimate that the city's capital revenues will average SEK4.8 billion annually in 2019-2021, compared with SEK3.2 billion in 2018. We understand that Stockholm will improve its self-financing, at least in part, by increasing asset sales, both at the city level and in the company sector. Due to uncertainty regarding the timing and materialization of these transactions, we forecast such revenues conservatively. However, we acknowledge that if they materialize, Stockholm's borrowing needs would reduce.
In our view, Stockholm's contingent liabilities remain limited. Despite the company sector's relatively large size, we consider the substantial surplus values within its properties and the financial strength of the companies a counterbalance.

We continue to view Stockholm's liquidity position as strong, supported by internal cash generation and an ample amount of contracted liquidity facilities with banks and multilateral lending institutions, relative to the city's coming 12-months debt service. Stockholm funds itself via a wide range of sources, including capital market borrowings and loans extended by the European Investment Bank and Nordic Investment Bank. In our view, the city's treasury adheres to prudent financial policies, which minimizes the city's refinancing risks. Similar to other Swedish LRGs, the city benefits from strong and reliable access to capital markets, even during strained credit conditions.
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