Italy's City Of Rome Assigned 'BBB-' Rating; Outlook Stable

  • Rome benefits from its position as Italy's administrative and government center, however we expect it will undergo slow economic growth in line with Italy.
  • We expect gradually weaker financial performance, due to increased spending needs for essential services, and slowly declining debt levels.
  • We also take into account ongoing government support, expressed through the central government's contribution to Rome's debt servicing via Gestione Commissariale (GC).
  • The rating is constrained by our opinion that Rome will likely face pressure to increase spending to improve public services, while it also faces very high contingent liabilities from its corporate sector and litigations.
  • We are assigning our 'BBB-' long-term issuer credit rating to Rome, with a stable outlook.

Rating Action

On July 19, 2019, S&P Global Ratings assigned its 'BBB-' long-term issuer credit rating to the Italian city of Rome. The outlook is stable.

Outlook

The outlook on Rome is stable because we expect slowly declining tax-supported debt, despite our anticipation of relatively weaker financial performance in the coming years due to moderate spending growth to improve the quality of public services.
Downside scenario
We would downgrade Rome if we expected a deterioration of its budgetary performance, deviating from our current base-case forecast, which would also likely increase debt levels. This could happen if operating expenditure increased above the level we forecast due to unexpected spending, or through the substantial materialization of off-balance-sheet liabilities. Budgetary performance could also deteriorate if Rome were to increase capital expenditure (capex) funded through debt, which we do not currently foresee.
Upside scenario
We would consider an upgrade of Rome only if three conditions were met, all other things being equal:
  • Rome's debt burden decreased, for example as a result of a clear separation of the GC and the city, with Rome also totally delinked in terms of revenue contribution.
  • Rome reduced meaningfully what we currently view as very high contingent liabilities, due to generally improving financial conditions of its most important government-related entities (GREs).
  • We no longer view underspending as a risk weighing on Rome's financial performance.

Rationale

Rome's economic and political weight lead to strong government support
Located in the region of Lazio, with a population of 2.87 million inhabitants at year-end 2017, Rome is the largest Italian city and represents about 4.7% of the national population. Rome is the governmental and administrative center of the country and the service sector, which includes the public sector. The latter remains at the core of its economy, accounting for 89% of the local workforce and generating 87% of the city's gross value added. Regional GDP per capita exceeded the national GDP per capita by about 13.1% in 2017 and the unemployment rate (metropolitan city data) is below the national average (9.5% versus 11.2% nationally in 2017). We believe, however, that Rome--like the country as a whole--will post slow economic growth in the coming years, which constrains our view on the rating.
Cities in Italy operate within an institutional framework that is characterized by a relatively high level of central government control and support. In recent years, the system has demonstrated a willingness to improve transparency and accountability. Italy's accounting reforms are progressively forcing cities to improve programming capabilities and align expenditure more closely with the level of revenue effectively collected.
In the case of Rome, we believe that the central government, although not always explicitly, grants a level of support that is different than for other cities. The central government created a specific vehicle (GC) to manage Rome's historic debt, which is still unique in the Italian context. No other city has been allowed to transfer all of its old assets and liabilities to a separate entity, or received such explicit direct support from the government to service it.
We view debt managed by GC as the city's responsibility, although it does benefit from government support
Rome's debt burden figures are strongly affected by its links with GC, which carries assets and liabilities prior to April 28, 2008.
We consider the historical financial debt of Rome in the hands of GC as its tax-supported debt. This is because, contrary to Rome's direct debt, it is not paid directly by Rome.
The debt held by GC is paid jointly by the central government and Rome. The city contributes €200 million per year, while the central government contributes €300 million. This debt stood at €4.96 billion at year-end 2018. Regardless of who pays, we would consider the nonpayment of such debt a default of Rome because the contracts are in the name of the city and have not changed.
Aside from its financial contribution to the servicing of Rome's debt managed by GC, Rome receives other types of financial assistance from the central government.
For example, the central government's financial arm, Cassa Depositi e Prestiti, renegotiated a portion of Rome's historical financial debt managed by GC (€1.08 billion out of €4.96 billion at year-end 2018). As a result, GC will only pay interest on this debt in 2019-2021. The payments will be made directly by the central government, using both its own funds and contributions from Rome.
We also understand that the GC tried to negotiate the same conditions for other loans with private banks, but these negotiations have halted for now.
In addition, we understand, that GC will ask the central government to directly absorb a €1.4 billion bullet bond, if creditors agree. Should the Italian government explicitly take responsibility for this debt, including a change in the ultimate obligor of the bond, and a release of Rome's obligation to contribute to its repayment, we could exclude it from Rome's debt figures.
Despite the long track record of ongoing support, we understand that the central government is planning for the GC to be closed in a few years. In this scenario, all the remaining assets and liabilities of GC would go back to Rome.
For these reasons, we continue considering the historical debt of Rome managed by GC as Rome's debt.
Central government support has taken other shapes in recent years. The central government granted the possibility to GC to securitize part of the proceeds coming from both the city and the central government to generate more cash in 2011-2014 and transfer money to Rome (approximately €2.5 billion between 2011 and 2015 that was part of the liabilities in the hands of GC) among other things to replenish its liquidity reserves. Such securitization is paid directly by the central government with €180 million out of the combined €500 million that Rome and the central government commit to GC annually. We do not take into account the €180 million when calculating Rome's consolidated operating revenue for the purposes of the tax-supported debt ratio.
The central government intervened again in 2014 by granting €110 million for the extra costs that Rome undertakes for being the capital city of the country. Rome continues to receive these payments and cash and liquid assets currently very comfortably cover its future debt service requirements, which are extremely low (below 2% of operating revenue over 2019-2021), by more than 8x. However, we believe that these reserves are also high because Rome underspent in the past, and we think they will trend down.
We also consolidate in tax-supported debt (apart from GC's) the debt of Rome's majority-owned companies that we consider not self-supporting, although their financial debt is relatively moderate.
We believe that risks associated with Rome's GREs could arise from concerns over the quality of services provided. The reduced quality standards of essential services like transportation (ATAC) or waste collection (AMA), might put pressure on Rome to step in and increase its financial commitment, putting pressure on the city's budget. Given that Rome is the owner of these GREs, there could be additional contingent liabilities linked, such as potential recapitalizations.
Contingent risks also lie in the amount of commercial debt that will likely go back to Rome once the GC closes in a few years. However, we believe that this amount will be lower than the current level of commercial debt held by GC, which stood at €3 billion (including €600 million toward Rome) on Nov. 30, 2018.
Rome's performance is set to deteriorate slightly as it faces pressures to increase expenditure
Rome's performance in 2016-2018 was very sound, with operating balances averaging 12% of operating revenue in accrual and 4% in cash terms. This is because the city reduced spending on public services such as the maintenance of roads to comply with the restructuring plan agreed with the central government back in 2014. We believe Rome's financial performance over 2019-2021 will be weaker than the exceptionally high levels recorded over 2016-2018, both in accrual and cash terms.
We expect operating expenditure will increase from current low levels to restore the quality of public services. However, we do not foresee Rome posting negative operating margins again, because the city's management is striving to improve cost controls (although with difficulties). Some off-balance-sheet liabilities and litigations still persist. Furthermore, the essential services of waste collection and local transportation have not been entirely satisfactory to date and the financial performance of such entities has also come under pressure.
We forecast slight cash deficits over 2019-2021, although we expect operating margins to remain positive. We forecast minor recourse to debt and a partial use of cash reserves. We also anticipate slightly higher payment rates on expenditure, both operating and capital, which stem from higher accrued expenditure. In our view, Rome will increase its operating expenditure to improve services, with capex to increase from record lows in 2018 due to investments in metro Line C that are funded with central government transfers.
We believe Rome's recent performance in cash terms has partially reflected possible underspending. Furthermore, the city's revenue collection process has not always been smooth, particularly concerning some ad hoc taxes and tariffs like the waste tax and traffic fines. For this reason, we consider Rome's budgetary flexibility to be limited.

We expect investments to hover above €300 million over 2019-2021, on average, which is more than the €150 million paid in 2018. As a result, financing needs will be moderate and the city's direct debt will remain rather stable or only slightly increase. Tax-supported debt will trend down, principally due to the debt of GC.
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