downgrade

International ratings agency, Moody’s Investors Service, recently downgrades five South African municipalities regional and local governments (RLGs) and on Government-Related Issuer (GRI).

The affected municipalities are: City of Cape Town, Nelson Mandela Metropolitan Municipality, City of Johannesburg, City of Ekurhuleni and City of uMhlathuze.

The rating downgrades of municipalities reflect rising liquidity pressure as a result of material shortfalls in revenue collection, that Moody’s expects to last, in the context of very weak growth. South African regional and local governments are likely to draw down on cash buffers, with different starting positions, eroding their capacity to absorb future shocks.

In this environment, the reviews for further downgrade reflect high uncertainty about the RLGs capacity to secure financing well in advance of debt and other payments being due.

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Moody’s municipalities downgrades has taken the following rating actions

• Downgraded the long-term global scale and national scale issuer and debt ratings (LT GSR and NSR) to Ba3/Aa3.za (from Ba2/Aaa.za) for City of Cape Town and placed the ratings on review for downgrade. At the same time placed the short-term (ST) NSR issuer ratings of P-1.za on review for downgrade whilst the ST GSR issuer ratings of NP was affirmed.

• Downgraded the LT GSR and NSR issuer rating to Ba3/Aa3.za (from Ba2/Aaa.za) for Nelson Mandela Metropolitan, Municipality and placed the ratings on review for further downgrade.

• Downgraded the LT GSR and NSR issuer and debt ratings to Ba3/A1.za (from Ba2/Aa1.za) for City of Johannesburg and placed the ratings on review for further downgrade. At the same time placed the ST NSR issuer ratings of P-1.za on review for downgrade whilst the ST GSR issuer ratings of NP was affirmed.

• Downgraded the LT GSR and NSR issuer and debt ratings to B2/Baa3.za (from B1/A3.za) for the City of Ekurhuleni and placed the ratings on review for further downgrade. At the same time downgraded the ST NSR issuer ratings to P-3.za (from P-2.za) and placed it on review for further downgrade, whilst the ST GSR issuer ratings of NP was affirmed.

• Downgraded the LT GSR and NSR issuer ratings to B1/Baa1.za (from Ba3/A1.za) for the City of uMhlathuze and placed the ratings on review for further downgrade.

• Downgraded the LT GSR and NSR issuer ratings to B2/Baa3.za (from B1/A3.za) for Ekurhuleni Water Care Company (ERWAT) and placed the ratings on review for further downgrade.

• Downgraded by one notch the Baseline Credit Assessment (BCA) of City of Cape Town, Nelson Mandela Metropolitan Municipality, City of Johannesburg, City of Ekurhuleni and City of uMhlathuze.

The decision to downgrade the RLG ratings by one notch reflects the rising liquidity pressures as a result of material shortfalls in revenue collection, that Moody’s expects to last, in the context of very weak growth. South African Regional and Local Governments are likely to draw down on cash buffers, with different starting positions, eroding their capacity to absorb future shocks.

On average rated municipalities generate more than 80% of their operating revenues from fees for services provision. Some municipalities having reported declines of up to 10% in revenue collection during 2020, shortfalls which are likely to be widespread and persistent. As a result, Moody’s expects a material deterioration of gross operating balances and cash balances in FY2021 and FY2022.

Given the structurally very weak growth in the country and their limited budget flexibility the metros will continue to struggle to balance operations in the coming years, and deficits levels will likely be controlled through potentially large cuts in capital expenditure, which given the metros’ already significant infrastructure backlog will be credit negative.

Though some of these entities have liquidity reserves (sinking funds and investments), that provide some buffer in the short-term, further drawdowns from these reserves to make up for the revenue shortfalls will reduce the municipalities capacity to face future shocks and meet future debt maturities.

The continued strain in the operating environment, as South Africa continues to battle the Coronavirus through strict lock-down regulations, further exacerbates the pressures on the municipalities. In 2020, consumption spending was highly affected, as households also faced cashflow pressures.

This, in turn, caused payments of rates and services, to municipalities, to be a low priority for households. With the additional lock-down measures that have been applied, it is expected that a further decline in consumption spending, and therefore more pressure in municipal collection rates; and thus, operating and cash deficits.

Moody’s expects the Ba3 rated RLGs to demonstrate better risk controls, financial management and investment and debt management; which are expected to result in better resilience in the current environment, than the RLGs rated at B1 and B2.

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Environmental considerations for municipalities credit profiles

Environmental considerations are important to South African municipalities credit profiles. Water shortages are one of the most material environmental risks to the sector. South Africa is considered a water scarce country and drought is the most frequent environmental risk which has a direct impact on the sector’s revenues.

Revenues from water purchases account for 10% of revenues on average across the rated sector. Water supply risks are managed through partnerships between the central government, the Department for Water and Sanitation and respective municipalities, and some of the financial burden for implementing and maintaining diverse water sources will be carried by municipalities.

The metros have increased their focus on water related infrastructure investment in their 2020-2023 capital budgets. Northern Cape and Eastern Cape provinces have been declared disaster areas due to water shortages and they require funding from national government to alleviate the situation.

Read the full press release here